EuroEasy Research Institute: Bitcoin falls below $30,000, and the crypto community faces two trends since the May rate hike

According to EuroEasy market data, at around 8 a.m. Beijing time on May 10, Bitcoin briefly fell below the key level of $30,000, reaching a low of $29,735, a drop of more than 10% in 24 hours. This is the first time that Bitcoin has fallen below $30,000 since it peaked at $69,000 on November 10 last year. Half an hour later, the price of Bitcoin returned to above $30,000. At 10 a.m., the price of Bitcoin was temporarily reported at $30,891.

Bitcoin price trend (EURET data)

What is the direct cause of the Bitcoin price falling below $30,000? One view is that:

At about 2 a.m. today, the Bitcoin address of Luna Foundation Guard (LFG) transferred out 42,530.82 Bitcoins, which was worth about $1.319 billion. This stimulated panic selling among a large number of users. In addition, the stablecoin UST issued by Luna has recently broken away from the peg to $1, and its price has continued to fall. As the number one dollar algorithmic stablecoin with a total market value of $18 billion, the flash crash of UST and the similar operation of the issuer behind it have brought down the crypto market, which has been in a state of panic recently.

Of course, why is the crypto world so fragile recently? This also points to the ultimate reason for this round of plunge: the US interest rate hike.

On May 4, the Federal Reserve announced a 50 basis point rate hike, raising the target range of the federal funds rate to between 0.75% and 1%. At the same time, the Fed announced that it would reduce its nearly $9 trillion balance sheet from June 1 to match the rate hike and curb soaring inflation.

As soon as the news came out, the U.S. stock market and the crypto market rose slightly in a short period of time, because the panic sentiment had been largely digested in the early stage. During the meeting, Federal Reserve Chairman Powell ruled out the possibility of a 75 basis point interest rate hike, dispelling market concerns about overly aggressive interest rate hikes.

But soon after, the market trend took a sharp turn for the worse, with both the U.S. stock market and the crypto market closing sharply lower. After all, this was the first time since 2000 that the interest rate hike reached 50 basis points, showing the urgency of the Fed's tightening monetary policy, which had a devastating impact on the funding side and market sentiment.

However, in contrast, the U.S. Treasury yields soared and the U.S. dollar index hit a 20-year high, showing the positive effects of the interest rate hike. It can be said that the interest rate hike is a regrettable move by the Federal Reserve to rebuild the credit of the U.S. dollar at a critical moment when U.S. inflation is intensifying and the credit of the U.S. dollar is declining.

Specifically, the trend of panic selling has already been established, and the situation is tragic. The three major US stock indexes all gave up the gains of the previous few days, with the Dow Jones Industrial Average plummeting nearly 1,400 points at one point during the session.

1. It is rare for an economic recession to be accompanied by high inflation, so interest rate hikes bring greater uncertainty

As early as late April, investment firm Goldman Sachs released a report predicting that the probability of a U.S. recession in the next two years is 35%.

The report analyzes that the main challenge currently facing the United States is to narrow the gap between the number of jobs and workers and to reduce employment opportunities by tightening financial policies without significantly raising the unemployment rate, thereby slowing wage growth to a rate consistent with the 2% inflation target.

But what is currently troubling the Federal Reserve and Wall Street is that the overall economic recession in the United States coexists with high inflation rates, which is extremely rare in history. This contrast is even more acute from the intuitive data of two aspects:

First, the Wall Street Journal conducted a survey of 65 business, academic and financial professionals earlier this month, and the respondents generally expected the probability of the US economy falling into recession in the next year to be 28%, both higher than 18% at the beginning of the year and 13% a year ago. In other words, the elites have further lowered their expectations for the US economy, pessimism is growing, and the mainstream view has reached a further consensus on the US economic recession.

Data from The Wall Street Journal

Secondly, according to data released by the U.S. Department of Labor on April 12, the U.S. CPI rose 8.5% year-on-year in March, the highest level since December 1981. This figure is higher than the Dow Jones's 8.4% forecast, which also means that the United States has seen a level of price increases that has never been seen in the past 40 years.

Both the US Consumer Price Index (CPI) and the Producer Price Index (PPI) have reached historical highs

The direct comparison between the two clearly shows the inflation dilemma in the recession cycle.

As we all know, high inflation is associated with rapid economic growth, while large deflation corresponds to a significant economic recession. Therefore, the situation faced by the Fed's interest rate hike this time may be more complicated than in previous interest rate hike cycles, because the two black swan events of the COVID-19 pandemic and the Russia-Ukraine war have brought huge uncertainty to the world economy. Of course, the initiator of all this is the massive release of US dollars after the epidemic. Therefore, interest rate hikes are inevitable, and the subsequent macroeconomic and financial market trends are even more confusing.

2. Hawks and doves have great differences in the intensity of interest rate hikes, and the Fed's monetary policy in the future is still uncertain

With a sharp sword hanging high and a dilemma, tightening the money supply and controlling liquidity have become the "least bad" option. After all, Americans from top to bottom are concerned about whether they can avoid an economic recession.

City Index analysis believes that the S&P 500 index saw its strongest gain since 2020 on the day the Federal Reserve announced its latest interest rate decision, which is somewhat unusual in itself. It can be said that the decline seen on May 5 was an expected repricing. "In the final analysis, risks still exist, inflation is still high, and the Fed will continue to act actively.

Of course, those who firmly believe that raising interest rates can cure the US economic illness do not seem to worry about the pain caused by the plunge. Previously, the hawkish representative and President of the Federal Reserve Bank of St. Louis, James Bullard, even boasted: "Raise interest rates to around 3.5% by the end of the year."

Furthermore, "Eagle King" Bullard chose to ignore the "recession theory" put forward by investment banks and economics circles represented by Goldman Sachs: "It is too early to talk about recession now. Interest rate hikes have only happened once." Bullard predicts that under the tight monetary policy, the US economy will grow at a healthy pace exceeding the long-term trend in 2022 and 2023, and the unemployment rate will fall below 3%.

Whether it is a gradual, moderate, small interest rate hike or a radical, drastic, large interest rate hike, it has caused a direct and rapid impact on the relatively fragile crypto market.

In the third week of April, Bitcoin fell below the $40,000 mark again after nearly a month, and has continued to fall ever since.

Although during this period there were major news such as Russia’s announcement that “natural gas and other energy sources will be settled using Bitcoin”, judging from the market reaction, it only slowed down the downward trend.

From Bitcoin hitting a new high of $69,000 to its consecutive falls below the $50,000 and $40,000 marks, all are closely related to the Federal Reserve's monetary tightening policy.

As one of the world's major value objects, Bitcoin is still highly dependent on the stability of the US dollar and the global financial stability dominated by US finance. The policy direction of the Federal Reserve is the decisive force affecting the price of Bitcoin.

However, the Fed's policy making is not entirely based on financial markets, capital gains, retail profits and losses, and public sentiment. The rise and fall of U.S. stocks is only one of its reference bases, and the crypto circle is even more insignificant. Given the obvious downturn in the U.S. economy, subsequent interest rate hikes will inevitably proceed according to the timeline, not to mention that we have entered a historical tightening cycle. However, judging from the current attitude of the Fed, the option of raising interest rates seems to have room for flexibility and wiggle room. After all, Powell has already said: We have a good chance of a soft landing.

3. Based on two hypothetical analyses, what impact will this round of interest rate hikes have on the future of the crypto market?

Based on the above conclusions and the specific trends, we might as well make the following two hypothetical analyses on the future trend of the crypto market. This is for reference only and does not constitute any form of investment advice.

Possibility 1: The Fed will continue to be hawkish after its May meeting and raise interest rates by more than 3% throughout the year in an effort to curb high inflation.

Specific impacts may include:

1) The continued and substantial outflow of funds has affected the asset prices in the financial sector;

2) The US CPI drops to the level of the first half of 2021 or even lower, and the inflation problem is alleviated;

3) The U.S. dollar continues to appreciate, and its credit has been restored to a certain extent;

4) Bitcoin will most likely be forced to digest the “consequences of the dollar injection” since 2021 or even longer, and the mainstream view on its bearish expectations may deepen;

5) It will trigger a wave of interest rate hikes in various countries. That is, major countries and financial institutions will try to maintain the stability of their currencies and use more radical means to stabilize the existing international financial system.

For example, after May 5, the European Central Bank, the Bank of England, and central banks of developed countries such as Canada and New Zealand have successively confirmed their plans to raise interest rates.

6) In the long run, Bitcoin will gain more independent value positioning, and the crypto market may usher in a new period of stable development due to this stimulus. Because the prices of mainstream digital assets have bottomed out, a new batch of high-level institutions and retail investors will be attracted to buy at the bottom, and then after the dollar starts to release water, the rich returns brought by value investment will surface. Of course, during this period, the price of Bitcoin may be affected by major currencies such as the US dollar, euro, and ruble, causing some fluctuations.

Possibility 2: To avoid the risk of a U.S. economic recession, the Federal Reserve policy is to raise interest rates by less than 2% throughout the year.

Specific impacts may include:

1) The shadow of financial risks may engulf the crypto market, but it is good for Bitcoin in the short term to a certain extent, because the actual negative impact is less than the worst expectation;

2) The inflation rate of the US dollar has eased, but it is still not conducive to boosting purchasing power in the long run. The crypto market may be in a state of high structural risk and high value coexisting for some time in the future, and the trend of continued wide fluctuations may become the norm;

3) Of course, the United States has chosen not to fire the arrow that is ready to be fired, which will naturally lead to a series of chain reactions until the credit of the US dollar collapses. Although this qualitative change will take a long time to develop, the United States' consistent operation of harming its neighbors has almost made sufficient preparations for this quantitative change. The most direct and important changes are:

Major sovereign credit currencies will not wait to transfer risks, and the trust and adoption of the US dollar by major economies will gradually weaken, which will directly impact the international financial system dominated by the US dollar after World War II. Russia's unilateral announcement of decoupling from the US dollar is the prelude to this major change, but the war has accelerated this process.

4) Under the domino effect, the uncertainty in the global financial market has increased sharply, and the intensity is even comparable to the most hawkish interest rate hike, because the downward trend brought by the latter is completely predictable. In this case, the Fed's inaction is equivalent to hinting that a large amount of safe-haven funds will enter the crypto circle in disguise. After all, Bitcoin still has the attributes of a risky asset. This characteristic has only been diluted by the large amount of US dollars and the strong correlation with US stocks. But when the conditions for its turn begin to fail, Bitcoin's original safe-haven properties are likely to be strengthened again. At that time, the price fluctuations of crypto assets will become more confusing, and it will be more difficult for investors to make profits in short-term operations. Therefore, the judgment and estimation of risks, plus the ability to adjust operating strategies in a timely manner, and even to calm personal fluctuations, are more important.

From the performance of digital assets such as Bitcoin during the Russian-Ukrainian war, we can see that the cryptosphere has been fully integrated with the global financial market, but in a special form. More and more central banks in mainstream countries have begun to formally recognize the status of blockchain technology and crypto assets, and underdeveloped countries in Asia, Africa and Latin America are also accelerating the process of legalizing Bitcoin. These phenomena have begun to frequently appear in the headlines of international mainstream financial media.

Looking back at the economic cycle of the past decade since the birth of Bitcoin, it is not difficult to find that every time a trough is crossed, the total market value and tenacity of Bitcoin will reach new highs. Therefore, no matter how strong, how large, or how the US rate hike is, it is a wise move to be bullish on the crypto world, choose Bitcoin, invest prudently, and improve awareness at this time to cross the bull-bear cycle.