By now, most of us have seen news regarding the US Fed raising interest rates flashing all over the place. However some of us may not be sure why it could affect crypto markets. Let us give a simple explanation to help you understand why.
Rising Interest Rates Are Bad For Businesses
As the world has been under a very low interest rate environment for the past 20-odd years, there has been an excessive amount of borrowing to fund almost everything. Families borrow at low rates to fund mortgages, companies borrow at low rates to fund business expansion, etc. Now that the Fed, and also, most other global central banks, need to raise interest rates to curb inflation, these borrowings will have to pay much higher interest rates compared with the norm of the past 20-years.
Such drastic rises in interest payments could have a serious negative impact on the finances of families and businesses. The financial markets are thus very concerned that this may cause problems for businesses, and worse, even cause insolvencies, which is why the stock markets are selling off heavily.
Correlation Between Stock and Crypto Markets
Ever since the COVID situation, there has been a strong positive correlation between the stock market and crypto market. This was not the case in the previous market cycle and many traders are hopeful that the old independence of the crypto market would return soon. However, for the current situation, this correlation is still very strong, which could be a result of traders holding both stock and crypto positions together and having to sell their crypto to meet margin calls in their stock portfolio. This correlation is especially strong with tech stocks, as we can see in the below diagram charting the trajectory of the price of Bitcoin and the Nasdaq. Notice that the correlation has been especially strong since November 2021 (blue box), which was the point in time when the Fed telegraphed that they would be raising interest rates. Both the Nasdaq and Bitcoin have been on a steep downtrend since, with Bitcoin being the more volatile one with a larger percentage movement.
Until this correlation breaks, the pressure on the stock markets, especially on technology stocks, may continue to put a damper on crypto prices.
Other than the correlation with stocks, there is another reason why the FED raising rates will be bad for crypto - the strong US dollar.
Why A Strong US Dollar is Bad For Crypto
Due to the US dollar’s status as the world reserve currency, every internationally traded asset is priced in US dollars. The same goes for commodities like gold, oil, and cryptocurrencies. Being priced in US dollars would naturally mean that when the US dollar goes up, the dollar-priced asset automatically becomes relatively cheaper in US dollar terms.
The rising US dollar is another reason why the prices of oil, precious metals, and cryptos, have been declining ever since the Fed started raising interest rates, and more so after the Fed grew more aggressive in raising interest rates.
Since the Fed’s decisions are so important, it would greatly benefit traders if they are able to predict, or at the very least, be informed at the shortest possible notice, what the Fed would do. Many experienced traders follow the Fed meeting calendar as well as key US economic data releases to try and beat others in the market.
How To Follow The Fed
The most imperative is to follow the Fed meeting dates to know how much interest rate, known as the Fed fund rate, is raising again, as well as to listen to Fed Chairman Powell’s press conference on his future guidance after every Fed meeting. A Fed meeting takes place every six weeks, and the next meetings are scheduled on November 2 and December 14 for this year.
Other than following the Fed meetings, there are other tips for a smart trader to know to be able to predict how much the Fed will raise in the upcoming meetings. This involves following the releases of economic figures the Fed monitors for them to base their interest rate decisions.
In particular, the Fed looks at two key economic figures that involve inflation to decide on what to do with interest rates - to hold, to raise, or to cut. Specifically, the Fed looks at the Core CPI and the Core PCE numbers to determine inflation. If inflation is high, the Fed will raise interest rates, if inflation is falling the Fed will likely hold back, while if there is no inflation, the Fed will cut rates to induce spending by lowering borrowing costs for everyone, especially businesses, which it hopes would drive economic activities.
At the moment, we are at the stage of a high, yet continually rising inflation, which means that the Fed will need to raise interest rates aggressively to stop prices from rising further.
Key Events To Watch
As mentioned above, the Fed closely monitors the core CPI and PCE inflation gauges to base their interest rate decisions.
The key difference between the two is data source. While CPI uses data from household surveys, PCE uses supplier side data. In addition, PCE measures goods and services bought by all US households, while CPI only accounts for all urban households.
The key to note here is not between CPI or PCE as the two gauges do not vary widely, but the fact that the Fed uses “core” data, which excludes the imputation of energy and food prices. This sounds strange but it is true that the Fed does not take oil and food prices into consideration when determining inflation. This is why despite oil prices having fallen below $100 per barrel for the past couple of months, the Fed is still aggressively raising rates because the gauge that the Fed watches, the “core” gauges, have not fallen. Hence, it is important that we follow the “core” readings instead of oil prices!
The next core CPI release will be on October 13, which is a key data point the Fed will be considering at its November 2 meeting, while the data for the following month will be released on November 10, this will be important for the December 14 Fed meeting’s decision.
The next core PCE release date is October 28, which will be a key data point the Fed will be pondering over at their November 2 meeting, while the November 25 PCE data will be crucial for the December 14 final Fed meeting for the year.
Now that we know what the Fed bases its interest rate decisions on and when these data will be released, readers can monitor these data and anticipate what the Fed will do and in turn, make more informed trading decisions.