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The Fed May Trigger a Wave of Interest Rate Cuts: How Will a New Round of Monetary Easing Affect the Cryptocurrency Market?

Abstract : To a large extent, the Federal Reserve has become a reason for investors to be more optimistic about the cryptocurrency market. Although the effects of unstable factors such as trade friction have slowed down and the demand for hedging has declined, investors are still willing to pay higher prices for digital assets because of “the Federal Reserve cut interest rates for the first time in ten years”.

ChainDD
ChainDD

Aug 04

At 2 a.m. Beijing time on August 1, the Federal Reserve concluded its two-day policy meeting and announced that it decided to cut the target range of the US dollar base interest rate by 25 basis points to 2%-2.25% in line with market expectations. Moreover, this is the first time that the Federal Reserve cut interest rates in the past decade.

It is generally believed that interest rates cut will make the US dollar weaker and benefit some emerging markets. The Fed’s statement pointed out that they decided to cut interest rates because of the impact of the global situation on the US economy future and moderate inflationary pressures. However, the uncertainty of the US economy future still exists. When it comes to the future interest rate, the Fed said it will continue to pay attention to the US economic situation and take appropriate actions to maintain the US economic expansion.

The Fed’s statement also pointed out that they will end its balance sheet reduction plan on August 1st, two months ahead of the original schedule. Before the US dollar interest rate cut, four central banks executed same policy, including Brazil and three Middle East countries (UAE, Bahrain, and Saudi Arabia cut interest rate in July). The Brazilian central bank announced that the basic interest rate will be cut by 50 basis points from 6.50% to 6.00%, although the market was expected to cut interest rates by 25 basis points.

Before the decision of interest rates cut was announced, Bitcoin broke through the $10,000 mark again due to the market's expectation. As of now, the 24-hour increase percentage reached 4.42%. The interest rate cut will undoubtedly continue the bull of the cryptocurrency market since March 2019. Bitcoin prices have exceeded the $13,000 mark at the end of June, and although they remain at high levels volatility for the rest of the month. Investors are still optimistic about Bitcoin's performance in the next few months. To a large extent, the Fed has become a reason for their optimism about the market. Although the effects of unstable factors such as trade friction have been less of a problem now that it used to be and the demand for hedging is declined, investors are still willing to pay higher prices for digital assets under the expectation of “the Fed cut interest rates for the first time in a decade”. Bitcoin prices have risen 61% year-to-date, and the market's total market value has risen by 115% over the same period.

How does the Fed’s interest rate cut affect the digital currency investment market?

The first thing that needs to be clear is the purpose of the Fed’s interest rate cut. The so-called interest rate cut is actually the "Federal funds rate", which is the interest rate when a commercial bank borrows from the Fed. The Fed lowered its lending rate, and the interbank lending between commercial banks will turn to the Federal Reserve because the cost of lending to the Fed is lower. The lending rate of the entire market, therefore, will fall.

The decline in the lending rate will benefit the investment market in two ways. First, it will reduce the company's financing costs. Second, it means that companies can have a higher value under a lower interest rate. Therefore, the Fed will cut interest rates by 25 basis points and continue to benefit the performance of emerging market asset prices. On the other hand, the decline in the interest rate of the lending will also make the national debt to other investment markets. Therefore, the decision of the Fed to cut interest rates will stimulate the prosperity of investment markets such as stocks and futures.

At the same time, the digital currency has become a hedging asset tool that is one of the reasons for the rising market. Under the premise of unclear global trade prospects, the volatility of global financial markets will fluctuate intermittently, and the signs of economic slowdown have prompted the International Monetary Fund to further reduce economic growth prospects. Therefore, more and more investors will use digital currencies for hedging.

But in the long run, the impact of the Fed’s interest rate cuts on digital currencies is still difficult to estimate.

From a positive point of view, the blockchain technology has great potential, and the decentralization of digital currency has got rid of the central bank-led traditional currency issuance system. It is not affected by the issuance of legal currency and exchange rate changes. In theory, there is no inflation, no loss of exchange rate, and low transaction costs. People can quickly make transactions. So, the digital currency is suitable for hedging assets. At the same time, Bitcoin, which dominates the digital currency market, faces 50% inflation by algorithm every year. As Bitcoin’s deflation curve becomes more radical after halving in 2020, price increases are almost inevitable in a situation of short supply.

However, from a bearish perspective, although the Fed has repeatedly said that the interest rate cut is a "safe rate cut" in response to a possible economic cycle, in the eyes of investors, this largely means the economy of the United States has weakened. It will affect the global investment market. In addition, the supervision of various countries is still unclear about the attitude of the digital currency industry. Regulators may raise the hammer of strong supervision at any time to avoid the overall economic downturn under the loose monetary policy. In other words, as the Fed begins to enter the interest rate cut track, once governments adopt relatively strict regulatory policies on digital currencies, the digital currency market will face correction in the future.

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