Rate Hikes and the Fed – How Do They Affect Crypto Markets?

In the past few years, the Federal Reserve has been at the forefront
of economic headlines after combating The pandemic induced economic issues
with aggressive quantitative easing. Interest rate hikes are now
being introduced to combat high inflation. So picture this. It's a nice Thursday afternoon
in the month of March and a relatively Inexperienced trader,
Mike opens his Binance account And he finds that his Bitcoin long
has been liquidated. He sighs and then exclaims, What?? It was moving up nicely just an hour ago. Struggling to find a good explanation
from the market crash, He asks his more experienced trading
buddy, Let's call him Abdul for advice. And after a quick back and forth, Mike learns that the federal Reserve
had an announcement, a rate hike of 25 Basis points and the market
apparently did not like the news. There are many stories just like this one. So let's help Mike Allen by discussing how rate hikes
by the Fed affect the crypto market. My name is Trevor with CMC and let's dive
right in. So what is the Federal Reserve? The Fed or Federal Reserve Is the institution
tasked with maintaining the U.S. Economy. And as the central bank of the U.S.,
it has three primary objectives. Maximum employment, stable prices, i.e. Low and stable inflation rates, and
then moderate interest rates in the U.S. Economy. So when it comes to a maximum employment,
the Fed strives To create the highest level
of sustainable employment. Considering factors Like job growth, a labor force
participation and unemployment rate. So by adjusting its monetary policies,
the Fed can foster an economic environment That promotes job Creation and stability in the labor market
and therefore stable prices.

This means keeping inflation
under control, And that's essential
for fostering economic certainty and also Maintaining the real value of money
and promoting a long term economic growth. The Fed targets a 2% inflation rate
over time as part of its price Stability mandate. So then when it comes to moderate Long term interest rates, maintaining
moderate long term interest rates Can generate sustainable economic growth
and also investment By influencing short term interest rates
such as the federal funds rate. The Fed can indirectly impact
a long term rates and contribute To a stable
and healthy financial environment. So in other words, the Federal Reserve
must create an environment Where prices are stable
and new jobs can be created. So to do this, it
monitors risks in the economy And frequently makes changes
to its monetary policy. So that brings us to the question,
what is monetary policy? Well, monetary policy is the set of rules Made by a central bank of a nation
aimed at controlling The supply of money to the economy
and achieving the primary objectives That we just discussed. So maximum employment, low and stable
inflation and moderate interest rates. So central banks can make changes
to the monetary policy to combat inflation And rising prices create new jobs
or so often the effects of a recession. And that sense of monetary policy can be
viewed as a toolbox for central banks To steer the economy
in the desired direction. The most well-known tools in the monetary
policy are quantitative easing, Open market operations, interest rate
changes and reserve requirements. But central banks can have many more tools
at their disposal. This brings us to the question
what is the FOMC meeting? While the Federal Open Market Committee or FOMC meets
at least eight times a year? And if the situation calls For the FOMC may convene
for additional emergency meetings? This most recently happened after the bank
run crisis affecting two major U.S.

Banks. And at the meetings, FOMC members review
the economic situation and its potential Risks and also discuss if the situation
calls for changes to monetary policy. A notable example of this happened
after the pandemic hit, and the Federal Reserve resorted to injecting capital
into the economy at unprecedented rates. While this address problems in the short
term, it came with negative side effects. Inflation skyrocketed significantly,
peaking at 9.1% year Over year inflation rate in June of 2022. So the FOMC has been working on Bringing inflation back down
since then with interest rate hikes Which can affect employment
and cause in economic downturn. As you can tell,
the job of the FOMC is not easy. So what are interest rate hikes? When we speak of an interest rate hike? We refer to an increase in the federal
funds rate, the interest rate At which commercial banks can borrow
and lend money to one another overnight. The federal funds rate is a range of rates
that banks can use In borrowing or lending
since inflation got out of control. The FOMC has decided to hike
interest rates at least nine times, Pushing interest rates from 0.25% to 5%
in just over a year. And as of right now, the federal funds
rate sits at 4.75% to 5%. When the federal funds rate
increases, the cost of capital increases And it increases
the cost of borrowing for banks Who in turn charge
higher interest rates for their customers. Mortgages become more expensive
and the cost of commercial loans And credit card debt charges skyrocket. In other words, with a rate hike,
the Fed is making it more expensive To invest or spend money
resulting in the demand curve going down. If you've studied economics, you'll know
a decline in demand usually results In lower prices, bringing prices
and therefore inflation down. So using rate
hikes is like using a fire extinguisher. Do interest rate
hikes affect the crypto markets? Changing the federal funds rate. It doesn't just combat
inflation, it's effects

Can be felt throughout the economy
and even in the financial markets. For example, when the Fed cuts interest
rates, stock markets typically move higher Because the cost of doing business goes
down, which increases the profitability Of publicly traded companies. In contrast,
an interest rate hike usually pushes share Prices down
as the cost of doing business increases. Cutting earnings. And because of the correlation between
stock markets and crypto, a bearish Reaction in the stock market also results
in a downturn for your tokens. Nevertheless, the biggest short term
effects of rate hikes are psychological. Markets are great at pricing information
and they often move in anticipation Of FOMC decisions. For example, the market pushed
higher on March 22nd, expecting a rate Hike pause when the Fed announced
the recent 25 basis point rate hike. A 7.9% correction
in the price of Bitcoin happened. And at the start of this rate
hike cycle, the announcement of a 25 Basis point hike came as a surprise,
resulting in a strong sell off. Now, all in all, it's clear
that the Fed has a strong influence On financial markets. Their quantitative easing program pushed
asset prices to all time highs in 2021, And rate hike decisions have also pushed
prices back down in the past year. At this moment, the market has become
more used to rate hikes And their impact on short
term prices has waned. So it's incredibly difficult
to predict interest rate decisions And even harder
to predict their effect on the market. Nevertheless,
it is useful to have a basic understanding Of the driving forces behind economies,
and it will help you understand Why markets move the way they do.