Interest rate cuts: how do Fed rate cuts impact crypto prices?

For those new to the world of crypto, understanding the intricate relationship between traditional financial markets and the digital realm can be daunting. One such connection lies in the impact of interest rate cuts by the Federal Reserve, which is now making headlines in mainstream media. Many traditional finance (TradFi) and crypto traders are speculating on a potential bullish rally. Will this truly be the case when the Fed makes the call to cut rates? From understanding what the Federal Funds Rate is to exploring its macroeconomic impact, this guide will dive into the impact of interest rate cuts on crypto prices and how traders can better position themselves ahead of such a hotly anticipated catalyst.

TL; DR

• Potential Fed interest rate cuts would likely influence crypto prices and determine its trajectory for the rest of the year.

• Some bullish crypto traders believe lower interest rates can stimulate economic growth and increase demand for riskier assets like crypto.

• Bearish crypto traders are highlighting that the overall health of the economy, market sentiment, and possible regulatory changes may dampen the potential rally of crypto prices.

• New crypto traders should be aware of increased volatility and consider risk management strategies like hedging and dollar-cost averaging.

• Understanding the factors influencing crypto prices can help you make informed trading decisions while navigating through such a major catalyst.

What is the Federal Funds Rate?

The Federal Funds Rate (FFR) is the interest rate at which banks lend reserve balances to each other overnight in the federal funds market. As such, the FFR is a vital monetary policy tool used by the Federal Reserve to control the money supply and is typically used to influence interest rates throughout the economy.

Application of the FFR in the broader economy

The FFR serves as a powerful monetary policy tool for the Federal Reserve to influence economic conditions. By adjusting the FFR, the Fed can potentially achieve a variety of goals.

Stimulating economic growth

When the Fed lowers the FFR and cuts rates, it becomes cheaper for banks to borrow money. This encourages them to lend more to businesses and consumers, stimulating business investments and spending. Lower interest rates also tend to make borrowing more affordable and attractive for individuals and businesses, leading to increased demand for goods and services. This increased borrowing and lending ultimately contributes to greater growth, since the expansion of businesses requires them to hire more workers.

Curbing inflation

To combat inflation, the Fed can raise the FFR. This makes business loans more expensive, discouraging spending and demand for overall business expansion. Higher interest rates can also make large ticket purchases more expensive in the long run because of higher borrowing costs. This can help to reduce inflationary pressures and keep rising prices under control.

Maintaining financial stability

By carefully tweaking the FFR, the Fed can help to prevent economic recessions and attempt to achieve a soft landing for the overall economy. If the economy is overheating and inflation is rising, the Fed can raise interest rates to prevent a bubble from forming. Once the economy begins slowing down, the Fed can lower interest rates to stimulate growth. And beyond economic recessions, the FFR can also influence the risk of credit defaults. When interest rates are low, there’s a higher risk of borrowers defaulting on their loans because of the overly attractive borrowing rates. The Fed can help to manage this risk of incurring bad debt by gradually raising interest rates as the economy strengthens.

Now that you’re aware of how the Federal Reserve can influence the broader economy through the Federal Funds Rate, let’s look deeper into the potential impacts that a rate cut could have on the crypto market.

Why is the Fed lowering interest rates?

To understand Fed rate decisions and why the Federal Reserve has held off on interest rate cuts for so long, it’s key to first grasp the string of events that led the US economy to its current situation.

A recap of what led to record-high inflation levels in the U.S.

Following the pandemic, the U.S. economy experienced a surge in inflation, primarily driven by supply chain disruptions, increased consumer demand, and government stimulus checks. Upon confirmation that inflation wasn’t transitory, the Federal Reserve implemented a series of aggressive interest rate hikes to combat inflation and keep it headed towards their ideal target of 2%. The Fed sought to slow down economic activity and ease inflationary pressures by hiking the FFR to levels previously seen during the dot-com bubble. The higher interest rates eventually began to impact economic growth, leading to concerns about a potential recession.

Too high for too long?

While “higher for longer” has been the approach of the Fed, given the overall stubbornness of inflation levels, it seems that new data might change the situation. Despite stellar earnings reports from top tech companies that highlight the strong growth of the U.S. economy, unemployment numbers are slowly creeping upwards. This begs the question: Is the economy in trouble after an extended period of high rates? With recession signals like the Sahm rule going off, fears that the economy might be slowing down more than previously anticipated have increased.

Potential implications of FFR cuts

Lower interest rates can stimulate economic growth by encouraging consumption and borrowing. However, it’s essential to consider the potential risks and trade-offs, such as increased inflationary pressures, market volatility, and the long-term economic outlook. While FFR cuts can boost the economy, they could also potentially exacerbate inflation. More generally, the long-term effects of FFR cuts on the global economy are notoriously difficult to predict.

The Federal Reserve’s alleged intention to lower interest rates is a significant development with far-reaching implications. While the intention is to stimulate economic growth and prevent a recession, it’s crucial to monitor the potential risks and trade-offs associated with this monetary policy change.

Understanding the inverse relationship between interest rates and crypto

Many traders believe that the relationship between interest rates and cryptocurrencies is inversely related. This means that when interest rates go down, the value of cryptocurrencies tends to go up. Conversely, when interest rates rise, crypto prices often experience a decline. Curious as to why this would be the case? This relationship is a result of the following factors.

• Opportunity cost: When interest rates are cut, traders often shift their funds from lower-yielding traditional assets like bonds to riskier assets like cryptocurrencies for the chance of achieving greater gains. This increased demand can potentially drive up crypto prices.

• Increased risk-on behavior: A lower FFR can whet the risk appetite of traders and get them to take on leverage because of the cheaper cost of borrowing. This can positively impact overall market sentiment and benefit crypto traders.

• Improved market sentiment: A low interest rate environment often creates a more optimistic market sentiment, which can benefit cryptocurrencies given that they’re generally perceived as risky and volatile assets to trade.

• Correlation with TradFi markets: As established with our Bitcoin and S&P 500 comparison, crypto often exhibits a correlation with TradFi markets. When the stock market rises due to lower interest rates, the crypto space may also experience a bullish rally because of the knock-on upward momentum.

• Favorable regulatory environments: In some cases, lower interest rates can lead to more favorable regulatory environments for cryptocurrencies. For example, during the pandemic, many countries around the world implemented significant economic stimulus measures, including lowering interest rates. In response to the economic downturn and the need for job creation, several governments took a more lenient approach towards regulating cryptocurrencies as some countries relaxed KYC requirements, reduced capital gains taxes on crypto trades, or even established regulatory frameworks to provide regulatory clarity for crypto businesses.

It’s important to note that the relationship between the FFR and the crypto market is nuanced and influenced by various factors. While a lower FFR can potentially create a favorable environment for cryptocurrencies, other factors such as market sentiment, technological advancements, and regulatory developments also play a significant role in determining crypto prices.

Historical analysis of interest rate cuts and Bitcoin prices

To better understand what might happen to crypto prices when interest rates are cut in 2024, let’s examine some key historical events and gauge the performance of the crypto market when the Fed proceeded with rate cuts. In these examples, we’ll be using Bitcoin prices as a symbol of crypto market strength.

Source: TradingView

The 2008 Global Financial Crisis

Following the Global Financial Crisis, the Federal Reserve implemented a series of aggressive interest rate cuts to stimulate the economy. As Bitcoin only emerged in late 2008 as a response to the banking inefficiencies highlighted in the 2008 disaster, we can use the stock market as a proxy for the performance of risky assets during a series of interest rate cuts. From 2007 to late 2008, the FFR plunged from 5.25% to 0.25%. This dramatic decline in interest rates coincided with a significant downturn in the stock market. As a broad measure of US stock market performance, the S&P 500 index declined by over 50% during this period. It’s important to note that while the stock market experienced a significant decline during this period, Bitcoin was still in its early stages of development. Its performance may not have been directly correlated with the stock market at this time. However, the broader trend of traders seeking higher-yielding assets in a low-interest rate environment could have theoretically contributed to Bitcoin’s growth.

2020 COVID-19 pandemic

In response to the economic downturn caused by the pandemic, the Federal Reserve implemented aggressive monetary policy measures, including lowering interest rates to near-zero levels and providing stimulus checks. These measures aimed to support the economy and prevent a deeper recession. The combination of low interest rates and stimulus spending created a favorable environment for risk-taking and aggressive trading. This contributed to a substantial rally in the asset market, including cryptocurrencies. In particular, Bitcoin experienced a significant price surge, reaching its then all-time highs in late 2021.

While these historical examples provide valuable insights, it’s crucial to remember that the cryptocurrency market has evolved significantly since its early days. Factors such as increased institutional adoption, technological advancements, and regulatory changes have influenced the relationship between interest rate cuts and crypto prices. Utimately, the inverse relationship between interest rates and risky assets is certainly more nuanced with these factors thrown into the mix.

Assessing the impact of 2024 interest rate cuts on crypto prices

To evaluate the potential impact of 2024 interest rate cuts on crypto prices, let’s consider the following factors.

Economic conditions

The overall existing health of the economy will significantly influence the effectiveness of interest rate cuts. As it typically takes a while for monetary policy changes to take effect, we can look at macroeconomic factors like Gross Domestic Product levels, the Personal Consumption Expenditure price index, and unemployment levels, since these data points tend to be bellwethers of the economy and often influence the policy direction that the Fed decides to take.

Market sentiment

Trader sentiment and risk appetite can play a crucial role in determining how crypto prices respond to interest rate cuts. While FFR cuts are often seen as bullish because of their short-term implications, bearish factors like geopolitical instability or regulatory restrictions can moderate the impact of interest rate cuts on the crypto market. On the other hand, positive market sentiment that’s driven by bullish factors like economic growth and technological advancements can amplify the positive impact of interest rate cuts on crypto prices.

Institutional adoption

What’s different with this cycle of interest rate cuts is the fact that there’s increased institutional adoption to take into account. Thanks to the introduction of spot BTC ETFs and spot ETH ETFs, big-name institutions that once had to sit on the sidelines can now actively gain exposure to crypto through these traditional investment vehicles. This ultimately provides a more stable foundation for the market and potentially levels out the drastic impact of interest rate cuts since institutional traders often have a longer-term perspective and may be less likely to react to short-term market fluctuations cause by FFR cuts.

While it’s difficult to predict the exact impact of 2024 interest rate cuts on crypto prices, historical data and current economic conditions suggest that lower interest rates could create a favorable environment for cryptocurrencies. However, the specific outcome will depend on the interplay of various factors, including those mentioned above.

Implications of interest rate cuts for new crypto traders

For new traders entering the crypto market, understanding the potential implications of interest rate cuts is crucial. Here are some key points to consider if you’re new to such levels of market volatility.

Managing the volatility that comes with such catalysts

If the Fed cuts interest rates, there could be a significant amount of volatility in the crypto market as prices whipsaw between highs and lows before settling down. As such, a highly leveraged trading portfolio could potentially run into margin call issues if left unattended. To prevent your holdings from getting forcefully liquidated, it can be a good idea to ensure there’s sufficient funding in your trading account or to make use of our take-profit and stop-loss orders.

Mitigating risk and hedging with crypto options

If you’re experienced with trading crypto options, you may want to consider hedging your overall holdings with crypto options. Given that the market is pricing in an upcoming rate cut, implied volatility (IV) will likely ramp up once FFR cuts are confirmed and the Fed officially announces its new interest rate decision. To take advantage of this, astute crypto option traders could consider a strangle options strategy given that crypto option premiums tend to spike in anticipation of such major policy events. Alternatively, crypto option traders may also consider defensive options like the covered call strategy to hedge and HODL at the same time.

Dollar cost averaging instead of going all-in

As Warren Buffett once said, time in the market is better than timing the market. If you’re intending to increase your exposure to the crypto market but are wary of the dump that could follow once interest rates are cut, you may be inclined to give dollar cost averaging a try. Since it effectively simplifies the trading process by removing the risk of emotions-based trading, DCAing could be an option to consider if you’re new to crypto trading.

Is it too late for rate cuts?

A hotly contested topic these days among traders hinges on whether the Fed comes too late with its FFR cuts. Some have posited in the past that the economy tends to break before the Fed reacts with interest rate cuts. In this view, the market endures a much deeper recession than would have been the case if the Fed had acted more proactively. This topic certainly deserves a deep dive given that US markets are potentially in a similar situation now.

This argument is based on the idea that the Federal Reserve often waits for economic indicators to deteriorate significantly before taking action to lower interest rates. By the time the Fed cuts rates, naysayers say, the economy may already be in a recession, making it more difficult to stimulate growth and prevent a deeper downturn.

There are counterarguments to this perspective, however. The Federal Reserve often relies on economic data that can be lagging, making it difficult to anticipate economic downturns in real-time along with how economic conditions can be unpredictable, and the Fed may be hesitant to act too aggressively for fear of overshooting its targets.

Ultimately, the question of whether the Fed is too late with its interest rate cuts is a complex one with no easy answer. While there are valid arguments on both sides, it’s clear that the timing of monetary policy decisions is both difficult and crucial for ensuring economic stability. With the lack of a perfect crystal ball, the Federal Reserve’s hesitation is understandable, since cutting interest rates prematurely can lead to inflation creeping back up while staying hawkish and keeping FFR high can lead to suppressed economic growth.

The latest on interest rate cuts

With the 25 basis point cut in November 2024 being only the second interest rate cut implemented by the Federal Reserve this year following the significant 50 basis point cut in September, it's clear that the Federal Reserve is still erring on the side of caution. In his latest Federal Open Market Committee address, Fed Chair Jerome Powell’s focus remains on guiding inflation back to the original 2% target, even as he gradually eases the existing monetary policy to support economic stability.

This measured pace suggests the Fed is attempting a soft landing to reduce inflation without triggering a severe economic downturn. While some analysts view the November cut as minor, it ultimately reflects the Fed’s assessment that inflation risks are diminishing. The long-term impact of this policy will depend on external factors, including potential changes in fiscal policy under the new administration, which could either support or disrupt the Fed’s inflation control efforts.

Curious about what's at stake in an all-new political environment? Our guide to the post-election crypto outlook considers the key crypto narratives that traders may want to pay attention to.

Final words and next steps

The Federal Reserve’s decision to lower the Federal Funds Rate in 2024 could have significant implications for the crypto market. While lower interest rates can stimulate economic growth and create a more favorable environment for cryptocurrencies, factors like market sentiment, regulatory changes, and technological advancements will also influence their impact. New crypto traders should be aware of the potential volatility, manage risks through hedging strategies, and stay informed about market developments to make the most informed trading decisions while navigating this dynamic landscape.

Wondering why some TradFi traders are rotating their funds into gold? Check out our in-depth comparison between gold and Bitcoin to learn more. Alternatively, if you’re keen to learn more about alternative assets, our crypto vs stocks guide will be right up your alley.