The Fed rate cuts could lead to monetary easing allowing fresh funds to flow into risk-on assets such as Bitcoin and other cryptocurrencies.
The latest Federal Open Market Committee (FOMC) minutes reveal increased confidence within the Federal Reserve (Fed) regarding their ability to manage high inflation. Projections suggest a potential interest rate cut in the coming year, with over half of Fed officials anticipating at least three 25 basis points rate reductions.
This anticipated easing of liquidity will prove a significant positive factor for Bitcoin (BTC), aligning with expectations of a spot ETF launch and the upcoming quadrennial mining reward halving on the Bitcoin blockchain. However, historical data from MacroMicro suggests that the initial phases of a Fed rate cut cycle, aimed at stimulating the economy, often coincide with the economy being on the brink of a recession. Moreover, there tends to be a brief but notable rally in the US dollar, a global reserve currency tied to the world’s largest and most liquid government bond market.
How Fed Rate Cuts Can Help Bitcoin
In practical terms, this historical pattern implies that Bitcoin might experience a brief and intense period of risk aversion later in the year when the Fed initiates rate cuts. A recession, characterized by prolonged economic decline and rising unemployment, can result in reduced risk-taking by investors and deflation in asset prices. Central banks typically respond to recessions with monetary stimulus to counter these effects.
The US dollar, as a global reserve currency, plays a crucial role in global trade, international debt, and non-bank borrowing. When the dollar strengthens, entities with dollar borrowings face higher costs for servicing debt. This tightening of financial conditions often leads to a reduction in exposure to risk assets like Bitcoin.
Examining historical instances, the dollar index, measuring the USD’s exchange rate against major fiat currencies, initially strengthened after the Fed initiated rate-cut cycles in mid-2000, September 2007, and August 2019.
During these periods, the S&P 500, reflecting global investor risk appetite, experienced episodes of risk aversion in the early stages of the rate-cut cycle, as illustrated in the shaded areas corresponding to recession periods following the Fed’s shift to rate cuts.
Ongoing Recession Fears
In a historical context, the Federal Reserve’s utilization of rate cuts has traditionally signaled the approach of a recession. The anticipation of rate cuts has prompted forward-looking markets to interpret them as indicators of impending economic challenges, leading investors to seek refuge in the U.S. dollar.
Based on data compiled by investment banking firm Piper Sandler spanning the last 60 years, a consistent pattern has emerged where recessions follow the initiation of easing cycles by the Fed. Piper Sandler noted that this pattern unfolds because the Fed tends to prolong high interest rates, unintentionally impeding economic growth. Rate cuts typically come into play when there are visible signs of economic decline and increasing unemployment, often marking an inevitable recession.
In a note to clients on January 2, Piper Sandler stated:
“This time around, it’s likely that the same pattern will repeat, with the Fed maintaining a hawkish stance longer than required.”
This perspective suggests an expectation that the Federal Reserve may continue a cautious and restrictive monetary policy longer than necessary, potentially contributing to economic challenges and reinforcing the historical correlation between rate cuts and impending recessions.