This week, to no great surprise, we saw another 25 basis point (bp) hike in the Federal Funds Rate. The increase itself isn’t that significant – background noise, if you will. We’ve all gotten used to that by now. What is remarkable about this one is that there is a strong possibility that it will be the last. This is a very big deal for the entire crypto market, not just Bitcoin (BTC).
Below, I dive into why I think this week will be the last US rate hike, why this is good news for Bitcoin, and why the tailwinds are spreading to other cryptoassets as well.
Noelle Acheson is the former Head of Research at CoinDesk and Genesis Trading. This article is an excerpt from their Crypto Is Macro Now newsletter, which focuses on the intersection between the changing crypto and macro landscapes. These opinions are hers and nothing she writes should be construed as investment advice.
Last week, US preliminary GDP came in at 1.1% qoq growth, much lower than the 2.0% expected and even lower than the fourth quarter downward revision of 2.6%. Most of the disappointment was due to weak inventory building, with defense and consumer spending accounting for most of the weak growth. Adjusted for inflation, consumer spending rose 3.7% in the first quarter, much faster than the 1.0% increase in the previous quarter. Remember, this hike comes after one of the steepest rate hike campaigns on record.
Unfortunately, this is reflected in the inflation data. The US Federal Reserve’s preferred index of inflation for personal consumption expenditure (PCE) excluding food and energy (known as the core PCE) for the first quarter rose 4.9%, ahead of the consensus estimate of 4.7% and the fourth .4% for the fourth quarter. The more accurate core PCE reading for March, released on Friday, showed no surprise increase but no decrease either, and was steady at 0.3% or 4.6% year-on-year. Again, frustrating resilience after nearly 5pp rate hikes in 12 months.
Since higher interest rates don’t seem to work, does that mean the Fed needs to raise them even more? Not necessarily. As the Fed has often reminded us, data moves with long and variable lags, with no indication of what “long” means. There are signs that the acceleration in core prices seen in the first quarter is abating. In addition to the March numbers, we have the Cleveland Fed Inflation Nowcast, which models the core PCE for April at a steady reading of just over 4.6%. This could encourage the Fed to wait and see if more impact materializes, which it likely will.
At the moment, this probability is not obvious. On Friday we saw that the labor cost index for the first quarter edged up 1.2% qoq. This is the Fed’s preferred measure of employment costs because it accounts for both benefits and wages and is therefore not skewed by shifts in employment between occupations or industries. The increase was just 0.1 percentage point, but that it was there at all is worrying, and the year-on-year increase was 4.8%, well above the target inflation rate of 2%.
But there are signs that the job market is cooling off. Thursday’s sustained US jobless claims held on to the rise seen in early April, with the last four readings up more than 6% from the previous four. The wave of layoffs hitting our headlines suggests that number is likely to keep rising.
Furthermore, when looking at the charts of the unemployment rate over time, what is striking is that it suddenly and rapidly starts to rise. The deteriorating credit outlook will further constrain economic growth as companies struggle to refinance, fueling even more layoffs, and the impact on demand will exacerbate painful dynamics.
Aware of these trends, I think it’s likely that the Fed will pause rate hikes at the Federal Open Market Committee (FOMC) meeting in June, and then hold on for some time as higher rates start to do their damage. We should not forget that the reported economic data are backward-looking. The US Conference Board’s Leading Economic Index fell 1.2% in March, more than double February’s decline. This downward trend is likely to continue as a result of a tighter bank lending role in the economy, punctuated by damage done to balance sheets by falling collateral values. Dark clouds are gathering.
If the Fed pauses in June, it would be good for Bitcoin as it implies an easing of financial conditions.
While interest rates themselves may not change, expectations of imminent rate cuts should be enough to move the liquidity needle – with the exception of the 1960s, a prolonged pause following a series of rate hikes was always followed by rate cuts. Furthermore, financial conditions are not only defined by the Fed Funds interest rate: they are also influenced by banks’ profits and policies, the price of oil, the level of the dollar, fiscal policy, and credit prospects around the world, among others.
While the Chicago Fed’s index of national financial conditions – which looks at both US capital markets and shadow banking – shows a tighter environment than a few years ago, it is on the way down, which means more market liquidity.
This is significant for Bitcoin as it is one of the most sensitive assets to changes in overall liquidity. You’ll often hear that “risk assets” benefit from looser monetary conditions. Well, Bitcoin is the ultimate “risk asset” in this regard:
We can expect BTC to continue acting as a liquidity barometer, as it did in January and again in March, once the Fed’s interest rate policy settles into wait-and-see mode. And liquidity is likely to increase as interest rates peak and the looming recession becomes more apparent.
While Bitcoin is the “macro” of all crypto assets, the macro environment also affects other crypto assets in different ways.
Bitcoin is still the anchor asset for the crypto market, with increasing dominance (percentage of total market cap) and high correlation with other tokens. In other words, what’s happening with Bitcoin affects sentiment across the market cap chart.
It does this through increased attention to the entire ecosystem, which encourages both new ventures and their funding. A rising BTC price justifies investments in market infrastructure and crypto asset services, which in turn supports access to and liquidity in other assets. Where BTC goes, the market tends to follow.
Additionally, once funds become comfortable with an allocation to BTC, many will look for even higher return opportunities, which means moving onto the risk curve. This tends to be encouraged by the easing of financial conditions, with potential gains more than offsetting the cost of leverage.
There is also the special case of ether (ETH), which is more directly affected by macro returns. Currently, staking on the Ethereum network earns around 5% in rewards, not counting price increases. This is less attractive to macro investors when US Treasuries offer similar risk-free returns, but when those fall the equation changes. Additionally, ETH’s relatively stable yield offers upside potential. Now that staking is flexible following the recent Shapella upgrade, macro investors are more likely to consider ETH in relation to other steady income opportunities, particularly if it is viewed as a window to greater participation in the ecosystem.
As the macroeconomic outlook and the likely trajectory of monetary policy finds itself in one of the most uncertain moments in recent history, taking a step back to look at the entire investment landscape can uncover opportunities and highlight narratives that didn’t exist the last time the global economy was in a similar location. For the first time, we have assets that do not depend on traditional economic considerations for their operation and that embody a range of new use cases that in turn bring resilience to investment thesis.
All economic cycles have certain patterns that tend to repeat themselves – this is one of the reasons they are called “cycles”. Crypto markets also have cycles, only historically these have mostly been driven by crypto-specific factors. Not anymore – now the crypto market has multiple drivers, adding complexity to the narratives while also opening the market to new investment cohorts.
This is not only intended to further close the gap between the crypto and macro landscape; it should also draw even more attention to the unique characteristics of crypto assets.
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