Inflation, the highest it’s been in decades, is at 8.5% right now and the Federal Reserve is going to do something about it. In this week’s article we’ll cover inflation, bonds, and how higher interest rates could affect the crypto markets.
Jerome Powell, the Chairman of the Federal Reserve, has stated that he’d like to see inflation get back to 2%. To get it there, the Fed is planning a series of rate hikes that will go into effect throughout the rest of this year and into next year. We already saw a 25 basis point rate hike in March, and Powell has indicated that the Fed’s planning to raise rates by half a percent in May.
Here’s Powell in his own words, quote,
It is appropriate in my view to be moving a little more quickly. - I would say 50 basis points will be on the table for the May meeting.
No matter how much the Fed raises rates in May, the bond market is already deep into the fastest sell off of the 21st century. From January 1st, the US 10 year treasury note, a commonly used benchmark for bonds, rose 70% from a 1.7% to 2.9% yield as of mid-April.
That’s a huge move in a market that’s traditionally quite sluggish. How could this affect the economy? The most troubling outcome is a slowdown in global growth. As interest rates rise so do borrowing costs. It becomes more expensive for companies to take out loans to expand their operations, and for entrepreneurs to finance their startups.
Higher interest rates also put a damper on consumer demand. Mortgages and credit cards are more expensive, and consumers have an incentive to save money since the yield on their savings account is higher. In the stock market, higher borrowing costs can force traders and investors to close out their leveraged positions and sell off those assets.
The net effect of raising interest rates is like taking oxygen away from the economic fire. The fire is still burning, but much more slowly.
We know how rates affect growth, but what we don’t know is how a higher interest rate environment is going to affect crypto. This will be the first time the crypto markets will have to contend with higher rates and there are a couple of ways that this could play out.
On one hand, rising interest rates are proof that inflation is high. Bitcoin has a reputation as an inflation hedge, so it could be that as rates rise so does the price of BTC. That’s what will happen if enough investors buy Bitcoin to hedge against the devaluation of the dollar. On the other hand, the higher cost of borrowing could force leveraged crypto investors to sell their positions. This could cause a washout in the crypto markets and a reset at lower prices.
Higher rates also create more of an opportunity cost of holding Bitcoin, since there are more opportunities to invest in other yield-generating assets. Nobody can say for sure what the ultimate effect of higher rates on crypto will be, we can only make an educated guess and size our positions accordingly. What’s your opinion, what do you think higher interest rates are going to do to the crypto market? Let us know in the comments section below!
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