With Rates This High Will The Next Crypto Bull Run Have to Wait?

Accelerating Rates = Bad, Stable Rates = Not So Bad

As an indicator of the relationship between rates and cryptocurrency prices, it’s worth recalling that the effective federal funds rate (the Fed’s base rate) was at 0.08% in November 2021. This was basically a record low, and it also happened to be when the crypto market hit an all-time high, with the abundance of cheap money making speculative assets more attractive to the average investor.

The effective federal funds rate since 2005. Source: Federal Reserve Bank of St. Louis

It’s no coincidence that the cryptocurrency market began falling once rates started rising from early 2022 onwards. Indeed, the market’s total cap hit a two–year low of around $820 million in late December 2022, just around the time the federal funds rate climbed to 4.33%.

The cryptocurrency market’s total cap since October 2021. Source: CoinGecko

Yet the key thing to remember is that it’s not simply higher rates in themselves that causes price declines, but also expectations of higher rates. It’s such negative expectations which have the biggest impact on price declines, and which also explain why the market fell faster during the main period of rate hikes, rather than when such rates actually hit their highest levels.

“What the market doesn’t like is rapid changes in the monetary landscape,” said JP Morgan Private Bank’s David Stubbs, speaking in January 2022.

Stubb’s remarks help to explain why a sudden ramping up of rates had such an outsized effect on crypto (and stocks) at the beginning of the Fed’s program of ‘quantitative tightening.’ Yet the higher rates have had less of an effect now, even though they remain at their highest levels in decades.

Another key to understanding the dynamic between asset prices and rates is that rising interest rates do not simply occur in a vacuum. In fact, such rates are likely to have an impact on consumers and business and, in turn, economies, with any potential decline in GDP likely to make investors even more negative.

For example, writing in a note to investors in May of this year, credit rating agency Moody’s forecast that the continuing increase in interest rates would likely push numerous developed economies towards recession.

“We expect very weak growth in key advanced economies in particular, including mild recessions in the US, UK and Germany, and stagnant economic activity in France and Italy,” its analysts declared.

This kind of forecast helps us to understand why the acceleration in rate hikes had a disproportionate impact on the cryptocurrency market. That is, the market likely interpreted such hikes as a sign of an incoming recession.

And understandably enough, anyone expecting a recession isn’t likely going to be too eager to buy speculative assets such as stocks and cryptocurrencies. Yet the key thing to consider here is that the global economic picture may not be as bad as many initially believed, and that markets may soon recover as a result, even if rates remain comparatively high.

For instance, many economists are increasingly beginning to expect a ‘soft landing’ from the course of rate hikes that the Federal Reserve and many other central banks have imposed on developed economies. Writing in an October 10 blog post, IMF Chief Economist Pierre-Olivier Gourinchas reported that “projections are increasingly consistent with a soft landing scenario, bringing inflation down without a major downturn in activity, especially in the United States.”

And with GDP growth in the US coming in at 2.4% in Q2 2023, such positive forecasts are likely to have a reassuring effect on markets and investors. In other words, a steady improvement in GDP growth and employment figures – as well as a decline in inflation – is likely to be enough on its own to begin boosting the cryptocurrency market, without interest rates necessarily having to come down immediately.