Fed policy and Bitcoin in 2024: Impact of Fed pivots
Another Fed pivot makes headlines as investors await lower interest rates with bated breath. Federal Reserve policies — and the narratives around them — affect all assets, including cryptocurrencies. Discover how the regulator’s altered stance may impact Bitcoin in 2024.
Defining Fed pivot
A Fed pivot is a turnaround in the policy of the Federal Reserve, the US central bank. Switching between expansion and contraction due to a revised economic outlook has sweeping implications.
- An expansionary policy (loosening) aims to stimulate economic recovery during downturns. It may include monetary measures (connected to the money supply), fiscal measures (related to government spending and taxes), or both. For example, the Fed purchases asset-backed securities from member banks, injecting money into the economy.
- A contractionary monetary policy (tightening) aims to slow down economic growth and constrict spending. It is implemented when inflation or the economy as a whole is deemed to be accelerating too fast. Common measures include selling government securities and raising interest rates and bank reserve requirements.
Thus, the regulator pivots when its stance ceases to be efficient in changing conditions. This year, the Fed is expected to lower its interest rates after 11 hawkish hikes between March 2022 and July 2023.
How a Fed pivot works
As the central bank of the United States, the Fed shapes the government’s monetary policy. Its mandate is dual: it is responsible for price stability and employment, two crucial data points for economic analysis.
Examples
Suppose inflation rockets while unemployment falls. These conditions create a risk of overheating, justifying monetary tightening. The response includes higher interest rates aimed at economic cooling.
A combination of low inflation and high unemployment makes recession a possibility. The regulator uses expansionary measures to stave it off: lower interest rates and more money pumped into the economy should revitalize it.
FOMC and fed funds rate
The term interest rates refers to the federal funds rate (fed funds rate), at which commercial banks borrow and lend each other their excess reserves. It is determined by the Federal Open Market Committee (FOMC), the branch of the Fed responsible for the direction of its monetary policy.
It comprises twelve members: seven Board of Governors members and five presidents of Federal Reserve Banks (one from New York and four on a rotating basis). Federal Reserve Banks are regional extensions of the regulator.
The committee meets eight times yearly to discuss the economic outlook and vote on changing the near-term policy. If a change is approved, the rates shift, and the Fed buys or sells US government securities on the open market. Each inflection point on the fed funds rate chart below marks a pivot.
Typically, the FOMC members include hawks (supporters of tight policies), doves (supporters of stimulus), and moderates or centrists. The chairman is also the chair of the Board of Governors. Currently, FOMC meetings are chaired by Jerome Powell, whose second four-year term began in May 2022.
How Fed pivots work
The impact of any policy is far from immediate — weeks or months pass before the economy reacts. Subsequently, the Fed stays the course to support stability and avoid market shocks.
When the economic fundamentals shift dramatically, comes the next turnaround. For example, a pivot from quantitative easing amid low rates typically includes rate hikes and the withdrawal of stimulating measures.
This process, known as tapering, may involve adjusting the discount rate or reserve requirements and reducing the Fed’s asset holdings. The possibility of a resulting downturn in financial markets — a “taper tantrum” — may cause hesitation as Fed officials seek to protect their constituents’ interests.
Similarly, if the interest rates are high, the Fed pivots in the opposite direction. It cuts the rates and implements monetary stimulus programs. As markets and analysts must revise their projections accordingly, the consequences are potentially just as disruptive in the short term.
Efficiency of Fed pivots
A common criticism of policy turnarounds concerns timing. Fed officials are blamed for reacting too late instead of taking preemptive measures, or abandoning their policy too early.
For example, in the 1970s, the tightening policy was terminated prematurely, letting stagflation set in. This phenomenon combines high inflation and unemployment with stagnant demand.
Insights from previous Fed pivots
Every pivot is a response to fundamental shifts in the US economy. Here are a few radical policy changes over the past two decades.
2001: Coping with dot-com bubble burst
For most of 2000, US technology stock prices soared on the back of investments in internet-based businesses. Toward the end of the year, that bubble started bursting.
Reacting to a mild recession, the Fed pivoted to a loose policy. The 9/11 terrorist attacks exacerbated the economic woes, and it took the regulator over 36 months to cut the rates from 6.5% (in late 2000) to 1.0% (in June 2003).
2004–2006: Taming real estate bubble
Rebounding from the dot-com recession, the US economy thrived. Easy money ensured by rate cuts helped the GDP balloon from +1.7% to +3.9% between 2001 and 2004. A bubble in housing markets became increasingly apparent.
In mid-2004, there was another pivot, with the interest rates creeping back from 1.0% to 5.25% over roughly two years. That hawkish streak included a spectacular 17 hikes.
2007–2008: Grappling with global financial crisis
The Great Recession (December 2007-June 2009), caused by the housing market crash, brought economic contraction with sweeping repercussions. High unemployment was accompanied by feeble growth and inflation stuck below the 2% target for several years.
Pivoting to an expansionary stance, the Fed slashed the rates from 5.25% to 2.00% between September 2007 and April 2008.
2018–2019: Putting tightening on hold
The next pivot came almost a decade later. Following three years of policy tightening, the rates approached 2.5% in 2019.
In December 2018, stocks crashed as an economic slowdown started. The hikes were paused one month later, and the market soared nearly 30% in 2019.
Throughout the year, the Fed cut its rates three times. It conducted a “mid-cycle adjustment,” as Powell put it, referring to the expansion-to-recession business cycle. The easing went from 2.25%-2.5% to 1.50%-1.75%.
2020: Quantitative easing triggered by COVID-19
In 2020, the US economy was rocked by the global COVID-19 pandemic and the consequences of lockdowns and business closures. Economic expansion, previously slow and steady, ceased.
Promptly pivoting, the Fed cut the rates from 1.5%-1.75% to nearly zero (0%-0.25%). They remained static until the spring of 2022. The regulator also resumed purchasing debt securities en masse — a tool it used during the Great Recession.
2022–2023: Prolonged tightening amid geopolitical crisis
In mid-2022, inflation exploded to levels last seen in the early 1980s. Several factors were at play — in addition to the aftermath of the COVID-19 lockdowns, the Russia-Ukraine conflict caused food and fuel prices to soar.
Launching an anti-inflation crusade, the Fed pivoted again, resorting to 11 hawkish hikes until July 2023. As of March 2024, it continues pursuing a target inflation rate of 2% YoY with full employment.
Fed pivots and Bitcoin
Higher interest rates favor the US dollar, scaring investors away from risk assets. Conversely, lowering rates — and the anticipation of cuts — benefit cryptocurrencies. What is good for the US dollar works against crypto and vice versa.
Two primary gauges of inflation in the US are PCE (Personal Consumption Expenditures Price Index) and CPI (Consumer Price Index). The Fed’s preferred indicator is the core PCE index, which excludes the volatile food and energy prices.
Hotter readings — and the rates enacted in response — support the dollar due to more robust economic activity. As cryptocurrencies are more expensive to acquire, short-term demand declines.
Inflation at or below expectations may positively impact crypto and other higher-risk segments like emerging market debt or CCC-rated corporate bonds. Even the anticipation of rate cuts is powerful enough to suppress US bond yields and weaken the US dollar index.
Grayscale partly attributes Bitcoin’s gains in late 2023 to the Fed’s monetary policy, particularly the signs of a looming pivot. In December, the coin gained 13%. At a press conference that month, Jerome Powell described dialing back policy restraint as a “topic of discussion.”
The subsequent BTC rally had many drivers. Today, just over two months after their launch, spot Bitcoin ETFs have amassed a collective market cap of $66.10B, eclipsing futures ETFs and even gold ETFs.
The following chart compares the behavior of Bitcoin and conventional assets. As real interest rates (the two-year yield on Treasury Inflation-Protected Securities) fell and the US dollar weakened, BTC tended to move up, and vice versa.
Predictability of Fed pivots
Over the past decades, the regulator has become more transparent, sharing its intentions publicly. Nevertheless, the timing of rate cuts and hikes is anyone’s guess. The CME FedWatch tool reflects the market’s expectations from each upcoming FOMC meeting.
Fed funds futures and options provide additional clues to market opinion — probabilities, not definite answers. Stocks are also susceptible to wrong timing. If the Fed reacts too slowly or its moves are misaligned with market expectations, prices drop.
Timing of 2024 Fed pivot
US inflation has been subsiding more slowly than the Fed hoped. The February CPI report — hotter than expected — pushed Bitcoin off its ATH of $73K on March 12, albeit temporarily.
In his recent public appearances, including the testimony before Congress, Jerome Powell stressed the need for more evidence of moderation. At press time, CME FedWatch shows a measly 1% chance of a rate cut in March versus 65% in June.
However, JPMorgan analysts suggest Bitcoin’s ongoing rally — with the latest ATH of $73,737.94 on March 14, 2024 —may delay the Fed’s cuts. The bank noted,
“Premature rate-cutting risks further inflating asset prices or causing another leg up in inflation.”
Furthermore, stocks have also reached record highs. Unless risk assets cool down, the fed funds rate could stay higher for longer, creating a less supportive macro background for BTC’s halving in April 2024.
💡 Read more: Bitcoin halving 2024: Ultimate guide
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