Anticipated Reduction in Fed Rates Bolsters Bitcoin’s Bullish Outlook, Yet There’s a Twist

The Federal Reserve

Last Updated on 2 months by cryptoevent

The Federal Reserve’s historical trend of implementing rate cuts has traditionally signaled impending recessions, prompting a shift of funds away from risky assets.

• The recently disclosed Fed minutes from Wednesday suggest a potential rate cut in the coming year.

• Historical data indicates that economic downturns often follow the initiation of rate cuts by the Fed.

The minutes from the Federal Reserve’s December meeting, unveiled on Wednesday, indicate a likelihood of interest rate cuts in 2024.

The eagerly awaited increase in liquidity has been widely acknowledged as a crucial positive force for bitcoin (BTC), along with the imminent launch of a spot ETF and the quadrennial reduction in Bitcoin blockchain mining rewards.

However, there’s a caveat. Past data from MacroMicro reveals that the initial phases of the ostensibly stimulating Fed rate-cut cycle are frequently marked by an economy teetering on the edge of recession and a brief yet noticeable surge in the U.S. dollar, a globally recognized reserve currency supported by the world’s largest and most liquid government bond market.

In essence, if historical trends hold, bitcoin might experience a brief and intense period of risk aversion later this year following the Fed’s initiation of cutting the benchmark Federal Funds rate.

A recession entails an extended period of declining economic output and an increase in unemployment. In the absence of intervention, a recession can lead to a sharp decline in investors’ risk appetite and deflation of asset prices. Therefore, central banks often counteract this with monetary stimulus.

The dollar serves as a global reserve currency, playing a significant role in global trade, international debt, and non-bank borrowing. When the U.S. dollar strengthens, those with dollar borrowings face higher costs in servicing debt, leading to tighter financial conditions and investors reducing exposure to risk assets like bitcoin.

The dollar index, measuring the USD’s exchange rate against major fiat currencies, initially strengthened after the Fed initiated rate-cut cycles in mid-2000, September 2007, and August 2019. The S&P 500, acting as a proxy for global investor risk appetite, experienced bouts of risk aversion during the early stages of rate-cut cycles.

The shaded area in the chart illustrates recessions that followed the Fed’s shift to rate cuts.

Do Rate Cuts Foreshadow Recessions?

Historically, the Fed has only turned to rate cuts when a recession is imminent. This has led forward-looking markets to interpret rate cuts as a sign of trouble, seeking refuge in the U.S. dollar.

Over the past 60 years, recessions have consistently followed the onset of easing cycles, according to data tracked by investment banking firm Piper Sandler.

“This sequence often occurs because the Fed tends to overshoot by raising and maintaining high-interest rates for longer than necessary, inadvertently stifling economic growth. Rate cuts usually come into play only when the economy is visibly declining, and unemployment is on the rise. By that point, a recession is typically inevitable,” stated Piper Sandler in a note to clients on Jan. 2.

Piper Sandler added, “This time around, it’s likely that the same pattern will repeat, with the Fed maintaining a hawkish stance longer than required.”

According to some observers, the markets may be currently overestimating the U.S. economy’s ability to avoid a recession following the steep Fed rate hike cycle that saw borrowing costs surge 525 basis points to 5.25% in the 16 months leading to July 2022. This leaves room for a negative market reaction to the potential onset of a recession.