Interest rate hike = bad news? Analysis of the impact of the Fed's interest rate hike on the crypto market

This article will start from the impact of the two monetary policies of interest rate hikes and quantitative easing on the price of Bitcoin, and then combine the attitudes of current monetary policy decision makers towards interest rate hikes. I hope it can bring help and inspiration to everyone in the interpretation of monetary policy.

1. Learning from history: interest rate hike = bad news?

Bitcoin is the originator of Crypto and a barometer of the market. We compare the internal Crypto indicators of Bitcoin's market value and halving cycle with external indicators such as the Federal Reserve rate and QE cycle, and discover the changing patterns between Bitcoin prices and these four sets of data from historical data.

Fed’s real interest rate (orange) vs BTC price (log, blue) vs Bitcoin halving cycle (red) vs Fed’s quantitative easing/balance sheet reduction

Image source: OKLink

Note: The green dashed line represents quantitative easing (QE), and the red line represents balance sheet reduction (QT). The horizontal dashed line represents the monthly bond purchase/balance sheet reduction scale, and the shaded area represents the total bond purchase/balance sheet reduction scale during the period.

BTC halving time: 2012.11.28｜2016.7.9｜2020.5.12｜2024.5 (estimated)

With the three halvings of Bitcoin, the price of Bitcoin has increased by 580 times, 128 times and 18 times in three bull and bear cycles.

At the end of 2012, Bitcoin completed its first block reward halving. After a slight correction in April 2013, it reached a stage high of $1,160 in November of that year, which lasted for 12 months. With low interest rates and the Fed's third QE (quantitative easing, September 2012-October 2014), the price of BTC has increased 580 times from the stage low of $2. At this time, the market value of Bitcoin was relatively small ($13.9b), and transactions mainly occurred in China. Therefore, the Fed's monetary policy did not actually have a significant impact on the price of Bitcoin.

In July 2016, Bitcoin completed its second halving. Prior to this, the BTC price completed two bottom confirmations: 2015.1 ($152)H and 2015.8 ($198). Since then, the price has been rising all the way, and reached a stage high of 19,600 18 months after the halving (2017.12), a 128-fold increase from the stage low. During this period, under the condition that the Federal Reserve did not engage in QE and the actual interest rate rose sharply, BTC rose against the trend, with a market value of $320.2b, a 22-fold increase from the previous high. It is worth noting that although the interest rate hike failed to curb the growth of Bitcoin, the balance sheet reduction in October 2017 had a significant cooling effect on the bull market.

Data from: Federal Reserve official website

The third halving took place in May 2020, and the upward channel was opened after the bottom confirmation of $3,850 was completed in March of the same year. At the same time, the Federal Reserve launched the fifth round of super QE in March to cope with the impact of the new coronavirus, and two months later the Federal Reserve interest rate fell to a nearly ten-year low. Due to domestic policy restrictions and the gradual favor of BTC by American capital, a major feature of this bull market is "Americanization", that is, the price of BTC and US stocks (especially technology stocks) show a strong correlation. The sufficient liquidity brought by the favorable monetary policy, coupled with the increasing recognition of Crypto by the traditional market, this round of bull market reached the current price high of $69,000 in November (19 months after the halving), which is nearly 18 times the bottom of the previous bear market, and the market value has increased by 2.94 times compared with the previous high.

The relationship between Bitcoin and the United States has gradually become closer, and the Federal Reserve's monetary policy has received widespread attention from the crypto community.

2. Who decides between hawks and doves?

The so-called "doves" and "hawks" originally originated from the media's description of political and diplomatic attitudes, especially war tendencies. Hawks advocate war and prefer to use tough means to solve problems and cut the Gordian knot; while doves advocate peace, sometimes boiling frogs in warm water. When these two words are applied to monetary policy, it means that hawks are more sensitive to inflation and hope to control inflation and stabilize prices by tightening monetary policy (such as raising interest rates and shrinking the balance sheet). Doves will pay more attention to stimulating employment and maintaining economic growth, and will enter the interest rate hike cycle later.

Monetary Policy

The monetary policy of the United States is formulated by the Federal Reserve. The so-called interest rate hikes and cuts by the Federal Reserve are adjustments to the U.S. federal funds rate, which are either unchanged or adjusted by at least 25 points. For example, if the interest rate is raised by 25 points from 2.25% to 2.50%, it will become 2.5% to 2.75%. The adjustment decision is announced through the Federal Open Market Committee (FOMC) meeting.

Federal Reserve & U.S. Government Cooperation Framework

Due to the voting system, the decision on whether to raise or lower interest rates is not made by the Fed Chairman alone, but by a committee of 12 Fed members. Below, we will briefly understand the composition of the Federal Reserve. The Federal Reserve has three key entities - the Federal Reserve Board (Board of Governors), regional Federal Reserve Banks (Reserve Banks) and the Federal Open Market Committee (FOMC).

Competent authority

The Federal Reserve Board of Governors, located in Washington, D.C., is the governing body of the Federal Reserve System. Board members are nominated by the President of the United States and confirmed by the Senate. The full board consists of seven members, but as of now (February 2022), only four are in office, namely, Federal Reserve Chairman Jerome H. Powell, Vice Chairman Lael Brainard, Board Member Michelle W. Bowman, and Board Member Christopher J. Waller. The remaining three were nominated by President Biden in January, namely, Sarah Bloom Raskin (left), who served as Deputy Secretary of the U.S. Treasury, to serve as the Board of Governors, and two economists, Philip Jefferson (center) and Lisa Cook (right).

Federal Reserve Board Member

Well, since the 7/12 committee members are nominated by the president, we have to refer to the president and his party’s attitude towards interest rates in history. Although the local Fed is not directly appointed by the president, the president can still indirectly influence the selection of the local Fed chair through the nominated directors. Looking back at history, the Federal Reserve under Democratic presidents seems to be more hawkish. Whether Biden will reshape a more "hawkish" Federal Reserve is worth paying attention to.

Fed Funds Rate vs President (Party)

Decision-making bodies

The Fed's main monetary policy tool is open market operations, which is the buying and selling of Treasury bonds and MBS. The Federal Open Market Committee (FOMC) is the decision-making body for U.S. monetary policy. At the FOMC meeting, 12 members vote to decide which monetary policy tools to use and how to use them. All seven members of the board mentioned above serve on the FOMC, plus John C. Williams, president of the New York Fed. These eight are permanent members of the FOMC. The remaining four members are rotated by the presidents of the 11 regional Federal Reserve Banks. Starting in January 2021, the presidents of the Boston Fed, the Cleveland Fed, the Kansas Fed, and the St. Louis Fed will serve.

Based on the public statements of regional Fed presidents, we summarized their inclinations on monetary policy. It can be seen that hawks are dominant.

It should be noted that since the interest rate hike is a foregone conclusion, how much and when the interest rate will be raised should be the focus of market attention in the future.

3. Expected Views

In the first two halvings, although the two monetary policies of interest rate hikes and quantitative easing did not play a decisive role overall, the halving cycle and monetary policy alternately affected prices. However, with the mainstreaming of BTC, the performance of this risky asset has gradually become associated with the attitude of the Federal Reserve, affecting market expectations in the short term. In the recent Bitcoin market, we can see a short-term rule, that is, when the hawkish remarks of the Federal Reserve meet expectations, the BTC price will rebound slightly; once it exceeds expectations, the price will fluctuate.

In addition to this type of short-term sentiment, it is also worth noting when the balance sheet reduction will begin in this round of interest rate hikes. Looking back at the entire process of the Fed's balance sheet reduction from April 2017 to October 2017, due to the full inclusion of expectations, the impact of balance sheet reduction on asset prices was relatively limited, and it was more dominated by growth factors. After the balance sheet reduction began in October 2017, U.S. bond interest rates rose in the first three quarters of 2018, and U.S. stocks also rose. The reason why the market continued to rise was not only because of full expectations, but also because the earnings fundamentals at the time continued to rise under the impetus of Trump's tax reform passed at the end of 2017, resisting the pressure of monetary tightening and interest rate increases.

In contrast, in this round of interest rate hikes, since the federal funds target rate is still the main monetary policy tool of the Fed, the market generally focuses on the pace of interest rate hikes, which may lead to insufficient digestion of expectations for balance sheet reduction. The minutes of the Fed's January FOMC meeting showed that Fed policymakers attending the meeting expected to start raising interest rates soon, and did not mention the possible timing and scale of balance sheet reduction. However, most participants believed that if inflation did not fall as expected, it might be appropriate to tighten the currency faster, and balance sheet reduction might occur in May. Compared with the digestion time of 6 months in 2017 and the policy benefits, if this round of balance sheet reduction really starts in May as expected by the market, it may have a certain impact on the market.

Although the Fed Committee is more "hawkish", I guess that in order to retain more policy flexibility, the Fed will not raise interest rates suddenly after the end of the tapper in March. Moderate interest rate hikes will wait for inflation and employment to respond. Forward, the pace of interest rate hikes can be increased or even the balance sheet can be reduced. For retreat, interest rate hikes can be kept at a small pace to balance economic growth, stability and inflation control to find a better monetary policy plan. However, once there are hawkish remarks or measures beyond expectations, holders of risky assets such as Crypto need to be well prepared for risk prevention and hedging.