Key takeaways
- Fed rate cuts increase liquidity, making riskier assets like crypto more attractive to investors.
- Bitcoin and other cryptocurrencies often see price surges during periods of monetary easing.
- Institutional investors treat crypto similarly to traditional assets, linking crypto markets to Fed policies.
- Rate cuts can create short-term gains but carry the risk of market bubbles and corrections.
What is the Fed’s rate cut?
The Fed’s rate cut is when the United States Federal Reserve lowers its benchmark interest rate, the federal funds rate. This rate influences borrowing costs across the economy, from mortgages to business loans. When the Fed cuts rates, it aims to make borrowing cheaper, encourage spending, and boost economic activity.
In September 2024, the Fed is expected to reduce rates by 25 basis points, down from their current level of 5.25%–5.50%, which has been in place since July 2023. This cut is seen as a response to cooling inflation and slower economic growth.
Typically, the Fed turns to rate cuts when it wants to prevent or soften a slowdown, as cheaper credit can help businesses and consumers spend more, helping to keep the economy moving.
This article is designed to help you understand how both traditional and crypto markets react to rate cuts and why this matters for crypto investors.
Did you know? The Federal Reserve, established in 1913, wasn’t always trusted by the American public. In fact, in its early years, people were so skeptical of central banking that the Fed operated out of a temporary office in the basement of the US Treasury Building to avoid too much public attention.
How traditional markets react to rate cuts
Rate cuts typically send equity and bond markets into overdrive. Here’s why:
- When borrowing becomes cheaper, companies find it easier to finance growth projects, which can lead to increased profits and higher stock prices.
- Investors also tend to shift their money from safer assets like bonds into riskier assets like stocks, looking for better returns. A clear example is the 2019 rate cuts when the Fed slashed rates three times, with the S&P 500 surging over 28% for the year as a result.
- However, as interest rates drop, the yield on new bonds falls, making existing bonds with higher yields more valuable. This happened during the Fed’s response to the COVID-19 pandemic in 2020, when rates were dropped to near zero, causing a strong rally in the bond market. Indeed, while some investors moved to riskier assets, others sought the safety of higher-yielding bonds, pushing up their prices amid global uncertainty.
So, rate cuts tend to drive both equity and bond markets higher, though in different ways.
Did you know? A bond is a type of debt security where the bondholder lends money to an issuer (typically a government) for a fixed period of time at a predetermined interest rate. In return, the issuer agrees to repay the amount on a specific maturity date along with periodic interest payments (known as coupon payments) during the bond’s life.
Impact of the Fed’s rate cut on crypto markets
Crypto markets, despite their decentralized nature, still react to broader macroeconomic policies like Fed rate cuts.
When the Fed reduces interest rates, liquidity in the financial system increases, as borrowing becomes cheaper for businesses and consumers alike. This increase in liquidity often spills over into the crypto market, as traditional assets like bonds and savings accounts offer lower returns, pushing investors toward higher-yield, riskier alternatives like cryptocurrencies.
This dynamic was evident in 2020 when the Fed’s aggressive rate cuts coincided with a massive bull run in Bitcoin (BTC) and other cryptocurrencies. With institutional investors seeking better returns and retail investors driven by speculative momentum, Bitcoin’s price had surged from around $7,000 in April to over $28,000 by December 2020. During periods of low interest rates, riskier assets like Bitcoin, Ether (ETH) and altcoins become especially attractive due to their potential for rapid gains.
However, this increase in liquidity also brings heightened volatility. Crypto markets, already known for their sharp price swings, can become even more speculative in these environments.
Lower rates allow for more capital inflows, but as hinted at further up, they also carry the risk of creating price bubbles, where the market becomes overvalued and vulnerable to sharp corrections.
Investors entering the crypto market during such periods need to be aware that while rate cuts might boost prices in the short term, they also increase the chance of unsustainable price surges followed by significant downturns.
Why crypto investors should care about the Fed’s actions
Large financial institutions, hedge funds and asset managers are now heavily involved in the crypto space, and their trading strategies often align with traditional market behaviors. When the Fed cuts rates, these institutions may reallocate capital to riskier assets like crypto, treating it as part of their broader risk management strategy.
As explored, low interest rates increase liquidity across the economy, meaning there’s more capital looking for profitable investments. As bonds and other safe assets provide lower yields in a low-rate environment, investors — especially institutional players — look to Bitcoin and altcoins for higher returns. This influx of institutional money often drives up prices, creating more demand and fueling bullish trends in the crypto market.
However, crypto investors, particularly those with lower risk tolerance, should be cautious during these periods. Rate cuts lead to speculative market behavior, and cryptocurrencies — known for their volatility — can see rapid price increases followed by sharp downturns.
Retail investors, who are often more exposed to these fluctuations, should pay close attention to the timing and extent of rate cuts.
Understanding how Fed policies impact the broader market can help crypto investors make more informed decisions and better navigate periods of increased risk.
Historical data: Fed rate cuts and crypto prices
2008 financial crisis
- Fed action: In response to the global financial crisis, the Fed cut rates to near zero.
- Crypto response: Bitcoin was born during this time, and while it was still too early for strong market data, many see Bitcoin’s creation as a reaction to the instability of traditional financial systems.
2019 Fed rate cuts
- Fed action: The Fed cut rates three times in 2019, aiming to extend economic expansion amid trade tensions and slowing growth.
- Crypto response: Bitcoin surged from around $3,700 in early 2019 to over $7,000 by the end of the year. Altcoins also saw gains as investors turned to crypto during easing monetary conditions.
2020 pandemic response
- Fed action: In response to COVID-19, the Fed slashed rates to nearly zero in March 2020.
- Crypto response: Bitcoin and the broader crypto market saw explosive growth. Bitcoin had gone from $7,000 in March to over $28,000 by December 2020, as liquidity flooded into all risk assets, including crypto.
2023–2024 high-rate environment
- Fed action: After raising rates aggressively to combat inflation, the Fed held rates at 5.25%–5.50% through much of 2023. As inflation slowed, the Fed signaled potential cuts in late 2024.
- Crypto response: Throughout 2023, Bitcoin’s performance was relatively flat, hovering between $25,000 and $30,000 as high rates dampened investor enthusiasm. However, expectations for rate cuts in late 2024 led to renewed interest in crypto investments.
Did you know? Institutional investment in Bitcoin surged dramatically in 2020, with companies like MicroStrategy and Tesla making significant Bitcoin purchases. MicroStrategy alone bought over $1 billion worth of BTC that year.
Potential long-term effects on crypto
The Fed’s rate cuts have both immediate and lasting implications for the crypto market. In the short term, lower interest rates often lead to increased liquidity, which can drive up prices for assets like Bitcoin and altcoins. But in the long run, the effects could be more profound.
For one, Bitcoin’s role as a potential hedge against inflation might become more prominent. If prolonged periods of low interest rates lead to concerns about currency devaluation, more investors may look to Bitcoin as a store of value, much like they do with gold. This narrative gained traction during the 2020 pandemic response, where Bitcoin’s growth coincided with fears about inflation following massive monetary easing.
Low rates also encourage innovation in the crypto space. With borrowing costs low, there’s more capital available for startups and developers to invest in blockchain technology and decentralized finance (DeFi) platforms. We might see a surge in crypto adoption and the development of new applications, particularly in periods where traditional financial institutions are less profitable due to low interest returns.
However, there’s a risk of bubbles forming. When liquidity is high, speculative investments often flood into riskier assets, which can lead to unsustainable price increases. This was evident in both 2020 and 2021, where massive inflows into crypto led to dramatic price spikes, followed by sharp corrections. Understanding this risk is crucial for long-term crypto investors navigating periods of aggressive monetary easing.
So, balancing short-term opportunities with long-term caution will be key as the Fed’s monetary policy continues to adapt.