The Federal Reserve's hawkish stance has brought the crypto market to an abrupt halt?

Recently, the market generally expects the US to shift to a tightening monetary policy. The statement made by Fed Chairman Powell on US monetary policy last weekend once again made this expectation full of variables. Powell said that the Fed may have more work to do in combating high inflation. "The Federal Open Market Committee (FOMC) is committed to achieving a sufficiently restrictive monetary policy stance to reduce inflation to 2% over time; we are not confident that we have achieved this point."

In recent days, the market has also been digesting the "hawkish news". From the perspective of monetary policy regulation, if the Fed continues to raise interest rates, the direct impact will be to increase the US dollar interest rate, making US dollar assets more attractive. At the same time, the price of Bitcoin fell after reaching a high point on November 10.

The US dollar is the world's main foreign exchange reserve currency, the United States' dominant position in the global economy, and many assets are denominated in US dollars, which gives the Federal Reserve influence in the global financial market. In particular, the reaction of overseas developed countries to the Fed's policies is highly similar to that of the US stock market. However, the inconsistency of the Fed's internal strategy led to misjudgment in the market from June to August this year. Some market participants mistakenly believed that the Fed had reached the peak of the interest rate hike cycle, resulting in a significant rebound in the risk market.

With the entry of institutions and the strengthening of compliance, the crypto market including Bitcoin will not be ignored. What is the correlation between Bitcoin and the Federal Reserve? Will this "niche market" continue to have the unique risk aversion of the niche market?

The on-chain and off-chain connectivity makes the crypto market more sensitive

Although crypto assets such as Bitcoin are niche assets, they have become increasingly correlated with financial markets such as the S&P500 and global overseas developed countries' stock markets since 2020. We can see that in terms of the correlation with major global stock markets (Equity F), the previous 0 correlation has become 0.25, only lower than the S&P500's correlation of 0.29. In terms of the correlation with financial factors (Financials F), it has changed from -0.03 to 0.19.

Source: IMF
Note: Smart C. = Smart Contract, F = Factor

According to the calculation results of the IMF working paper, the impact of US monetary policy on the cryptocurrency cycle is almost the same as that on the global stock cycle, which is in sharp contrast to the potential of crypto assets in hedging market risks. When the Federal Reserve's monetary policy rate (SFFR) rises by one percentage point, the cryptocurrency factor continues to decline in the following 15 days, which is about 150% of the impact of the stock factor decline, which means that the crypto market is more sensitive to changes in the Federal Reserve's monetary policy.

However, investors should also note that there is a disagreement between the market and the Fed. The market generally believes that the United States is at the peak of the economic cycle or ordinary inflation. However, although the Fed previously insisted that the United States is facing the peak of the economic cycle or ordinary inflation, its actual actions and measures are more radical. Therefore, the market has some doubts about the Fed's "inconsistent" position.

Whether it is the frequent positive factors such as compliance support and accelerated acceptance by institutions, or the conclusions from the data, we can clearly see that the on-chain crypto market is no longer niche, and the crypto market has been integrated into the global financial cycle.

With the impact of institutional entry, crypto investors need a macro perspective

As institutional funds pour into the crypto market, the market will become more mature. At the same time, professional investors usually pay more attention to changes in macroeconomic factors and monetary policy. The increase in the participation of institutional investors strengthens the transmission effect of monetary policy on the cryptocurrency market. This will increase the impact of the Federal Reserve's monetary policy on the market.

Arthur Hayes also pointed out in his latest article "Bad Gurl" that the bull market in the crypto market may come with the increase of US dollar liquidity, which is directly related to the US dollar's monetary policy. Therefore, forecasting from the perspective of the real economy and the global financial cycle, especially predicting the Fed's actions in advance, that is, managing "market expectations", will become one of the most important criteria for future market investors.

In addition to the Fed's internal "inconsistent" stance that has caused market concerns, we also need to pay attention to the external effectiveness of the Fed's monetary policy. Investors need to have a broader macro-pattern, such as referring to the dynamics of the real economy cycle and the overall environment of global financial operations. Considering the relative decline in the international status of the US dollar, the internationalization of the RMB, and the fact that the US GDP scale has no obvious advantage over the EU as a whole, academics such as Professor Scott Sumner have proposed the difference in the impact of the US monetary policy on the world's nominal economy, and proposed the difference between the "nominal superpower" and the "actual superpower".

Crypto assets such as Bitcoin are entering a new phase. With the participation of important stakeholders from all parties, from institutional investors to regulators, the crypto market is accumulating scale and influence at an unprecedented rate. At the same time, its price trend seems increasingly difficult to be isolated. In the short and medium term, even if the crypto market has the blessing of technology, independent market trends are a thing of the past. Compared with stock market investors, crypto investors also need to pay attention to the trend of monetary policy formulation under the multiple difficulties of inflation, financial stability and economic recovery from a more macro perspective.