The Fed’s Rate Cut Cushion Is Good News for Crypto

Many investors fail to grasp the true factors influencing central bank’s monetary policy, particularly interest rates. However, comprehending these underlying forces is crucial as they significantly impact the valuation of risk-based assets such as cryptocurrencies, stocks, and other securities – either causing their price to rise or fall.

According to most experts on Wall Street, they expect the Federal Reserve to decrease short-term loan rates from 5.33% currently to around 3.33% within the next year and a half. This implies that it will become less expensive for homes, businesses, and investors to obtain loans since there will be more money available and easier access to it, leading to increased investment opportunities.

The change will drive the value of assets priced in dollars, like bitcoin and ethereum higher. Let me explain.

Over the past few weeks, it appears our central bank may have the opportunity to decrease interest rates again. One of the strongest indications came in mid-August with the publication of consumer price index (“CPI”) data by the U.S. Bureau of Labor Statistics for July. This data showed that inflation had dipped below the 3% mark, a level not seen since early 2021.

Last week, Jerome Powell, the Federal Chairman, affirmed the upcoming shift. During his speech at the Kansas City Fed’s Annual Economic Symposium held in Jackson Hole, Wyoming, he suggested it was now appropriate to reduce interest rates. He pointed out that inflation has decreased to a level that allows for this adjustment. Moreover, he highlighted that the restoration of normalcy in supply chains and the recovery of labor supply have alleviated price pressures.

Despite the current circumstances, there’s a more significant influence at play. Interest rates have bounced back to levels not witnessed in nearly two decades. This shift suggests that our central bank has room to reduce rates now. In simpler terms, it can lower interest rates without accelerating inflation and maintain steady economic development.

As an analyst, when I’m discussing this topic, I might say: “If you’re new to this, the real interest rate serves as a crucial indicator that the Federal Reserve keeps a close eye on to determine whether their monetary policy is causing inflation to rise or fall. To understand this, they compare the effective federal funds rate (the rate at which banks lend to each other overnight) with the Consumer Price Index (CPI). If the real interest rate (the difference between these two figures) is negative, it suggests that the policy is fostering excessive growth. Conversely, a positive spread implies that rates are having a dampening effect on prices.”

As a researcher examining the data presented, I’ve observed an interesting pattern between the effective fed funds rate (represented by the blue line) and the Consumer Price Index (CPI, represented by the orange line), since the year 2000. Generally, before rate cuts, you’ll find that the fed funds rate tends to be higher than the CPI. Similarly, prior to rate hikes, the interest rates usually sit below the rate of inflation growth.

I’ve calculated the numbers for you and organized them neatly in the chart that follows for your convenience.

In the graph, the red line signifies the change in the interest spread we previously talked about. To the far right, you can see that the actual interest rate in June 2022 was -8.3%. This means that the policy was so lenient that it didn’t impact prices. At this point, the federal funds effective rate was nearly zero, while inflation reached its highest at 9.1%. Consequently, the Fed initiated a sequence of substantial interest rate increases to curb price growth.

Looking to the extreme right on the graph shows a significant shift in circumstances. After increasing interest rates from 0%, to a range of 5.3%, our central bank has altered the trajectory of price increases. Since reaching its high in June 2022, Consumer Price Index (CPI) has decreased from 9.1% to 2.9%. As a result, the real interest rate has climbed back up to 2.4%, indicating that our policy is exerting pressure on prices.

Currently, the actual interest rate is as high as it was back in July 2007, which was just prior to the Federal Reserve reducing interest rates again.

But how can we be sure that it can lower interest rates without stoking inflation growth once more?

Let’s analyze the average rate at which Consumer Price Index (CPI) has grown over the past six months, specifically 0.2%. Using this data along with the Bureau of Labor Statistics index information, we can make predictions about the projected growth rate for the entire year ahead. To complete our analysis, we’ll compare this forecasted growth to Wall Street’s anticipated federal funds rate for the upcoming year to determine the real interest rate.

Money strategists predict that the Federal Reserve will lower interest rates significantly in the coming months. They believe the federal funds effective rate could decrease from its current 5.3%, all the way down to as low as 3.7% by April 2025. This is a substantial change within a relatively short timeframe of less than a year.

On the other hand, inflation growth might significantly decrease within that same time period. Given the 0.2% average from the previous six months, the annualized Consumer Price Index (CPI) could be around 1.9% when the April 2025 data is unveiled. This would mark the first instance since February 2021 that it falls below the Federal Reserve’s 2% target.

To put it simply, these changes imply that the Federal Reserve might lower rates by as much as 1.75 percentage points within the next nine months, leaving them at a real interest rate of 1.8%. This means that even with a rapid series of rate cuts in a brief span, monetary policy would continue to exert downward pressure on inflation.

A significant shift could have a profound impact on economic optimism. Over the past few years, many people and businesses have purchased properties at high rates, which could potentially be refinanced, leading to lower interest payment rates. This reduction in costs would make big-ticket items like houses and cars cheaper, making them more accessible for many. Furthermore, the strain of paying off debts such as credit cards might lessen, freeing up resources for other expenses. Essentially, this adjustment would give both institutions and individuals extra spending power.

Over time, these events led to a transition in atmosphere – from one where the economy seemed precariously close to collapse, to one that appears capable of sustained expansion. This evolution is beneficial for robust earnings growth within U.S. corporations. Moreover, the Federal Reserve retains the flexibility to lower interest rates further if they deem it appropriate for continued adjustments.

As the day concludes, consistent financial expansion and enhanced confidence among consumers and corporations will spur increased investment in speculative assets from both individual and professional investors. Essentially, this shift is expected to boost the value of cryptocurrencies like Bitcoin and Ethereum.

Please be aware that the opinions expressed within this article belong solely to the writer and may not align with the views of CoinDesk Inc., its proprietors, or its associated entities.