The Fed, Interest Rates and Crypto

Cryptocurrency markets and stock markets around the world eagerly awaited todays announcement from the Federal Reserve (Fed) regarding interest rates.  The hawkish stance from the Fed and signals of rate hikes (3-4) in 2022 have rattled the global markets this month and as result cryptocurrencies have spent a lot of time the past few weeks in the red.  But why is the Fed raising rates and why does the crypto world care?

Since the 2008 financial crisis interest rates have been close to zero making borrowing money virtually free.  Rates are so low that even a fairly significant raise in interest rates will still leave them near historical lows.

In the crypto world, companies focused on blockchain technology, NFTs, exchanges and virtually everything else dealing with crypto have been able to attract large amount of venture capital.  Everyone wants a piece of that tasty crypto pie.  When rates rise, investors start to sit on the sidelines rather than put their money where they think it can grow and speculative crypto projects are a prime area in which investment dollars slow dramatically.

We are seeing more and more of a correlation between the crypto and stock markets.  While crypto has only been around since 2009, stocks have been around for over 100 years and for the last 30 the Fed has done everything in its power to prop up stock assets.  The recent drop in the stock market, while not as severe as crypto, may help lessen the Feds resolve to raise rates and weaken equity prices.  It is a delicate balancing act trying to deal with the highest inflation in nearly 40 years while also keeping markets happy all during a global pandemic, but that is the task the Fed faces right now.

As the S&P 500 goes, so goes Bitcoin and as Bitcoin goes so does the rest of the crypto market.  I had really hoped to enter the crypto market to diversify my portfolio even further, but the more I get into digital currencies the more I realize that I'm not really diversifying with much success by adding these coins and tokens.  Not that I'll leave crypto now, I'm hooked, but I will need to look elsewhere to diversify.

When I was initially getting into crypto last year I kept hearing how Bitcoin was a hedge against inflation.  We are now going to start really testing this notion.  If Bitcoin is really such a strong hedge it should be acting like gold which holds steady during inflationary times and during market turbulence, I'm not seeing this out of BTC recently.

After the beating crypto has taken the last few weeks prices have crept up the past few days, but volume has been limited as investors eyed the results of the Fed's two day meeting.  Any clarity coming out of the market in terms of both rate hikes and timing should help calm nervous markets but not necessarily.  The stock market immediately gave up its gains from earlier in the day in which saw the DOW up more than 500 points turn negative after the chairman indicted the Central Bank could further raise rates and Bitcoin quickly followed suit.

"We’re committed to our price stability goals," Fed Chairman Jerome Powell said today. “We will use our tools both to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched.”  He later added, "the economy no longer needs sustained high levels of monetary policy support," which sent markets lower.

Bitcoin sat above $38,500 about 15 minutes before the press conference began.  Nearly an hour after the press conference began, BTC had fallen to under $37,000 in a sign that the crypto investors didn't like what the Fed was saying.  As expected, the Fed didn't raise rates today but look to do so as early as March based on their comments.

What will be the impact on crypto with the tightening of monetary policy and higher interest rates?  I believe in the short run the crypto prices will feel the impact and much of this has already been factored into the market.  If inflation continues to spiral upward, that will have a very negative effect on all markets including Bitcoin and the other altcoins.

In the longer run, however, I don't believe this will have much impact as blockchain technology is here to stay and will only continue to improve and bring more innovation.  With more and more adoption of crypto, the demand increases will drive prices higher and higher in the long-run and that is the game here as with most investments but with more short-term volatility as it is still in the early stages of development.  Those that HODL will do well over time, just like those who hold onto stocks for the long haul.

Yes, crypto is impacted by inflation and the resulting actions of the Fed but the long-term outlook is very strong and I believe that in general will outperform most other forms of investment.  For those reading this, congratulations on getting in on this market in the early stages where patience will be greatly rewarded.