Bitcoin Shows Strength Despite Fed Increasing Rates

Bitcoin is Defying Predictions

On July 27th, the United States Federal Reserve hiked benchmark interest rates by 75 basis points or 0.75% to combat inflation at a 40-year high. At the news, Bitcoin surged by more than 10% to trade above $23k by Thursday, pulling along major altcoins such as Ethereum which climbed by 16% to pass 1660 and Ripple which went up by 8%. Bitcoin has sustained that rally and is currently exchanging hands above $24k.

July’s move is the fourth of this year, but the campaign against inflation is far from over, with the effects of the hike being unlikely to be felt immediately. Fed officials are expected to meet three more times in September, November, and December to decide the percentage of subsequent hikes. The institution faces a delicate balancing act — cooling off the economy and driving it into a recession.

Hiking rates mean higher costs and lower revenues. In short, bad news. So, why did Bitcoin and altcoins react positively?

Before diving into that, let’s quickly recap what’s been happening in the market. The leading crypto has faced several headwinds recently. Shifts in the macroeconomic landscape such as the Fed’s monetary policies, inflation, the deleveraging of major players such as Celsius, Three Arrows Capital, and Coinbase, etc have left the Bitcoin community feeling battered.

Meanwhile, it’s possible most people were expecting a higher hike than three-quarters of a percentage. So, the positive reaction is because the markets sighed a collective sigh of relief with a 0.75% bump.

“Markets have had enough time to digest and full price in a 75 basis point rate hike. Major crypto assets, including Bitcoin and Ethereum, have actually rallied in the immediate aftermath of the announcement,” observed crypto investment fund ARK36 CEO Mikkel Mørch. “This may suggest that market participants were actually quite fearful of the 100 bps and sighed with relief when the raise aligned with the consensus”, he added.

Why Is the Federal Reserve Raising Rates?

The Fed is hiking rates with a view to stemming runaway inflation. Inflation hit an all-time high in June for the first time since 1981 — accelerating to 9.1% from 8.6% in May, according to the Consumer Price Index (CPI). Low-income Americans are feeling the heat as prices of basic commodities soar, with gasoline, food and rent contributing the most to the increased index.

But it’s not just the US grappling with inflation. Events on the global stage mean governments worldwide are scrambling to cushion its effects on citizens. Some of those events are:

• The Russian Ukraine invasion and China lockdowns, which have disrupted global supply chains.
• Covid pandemic restrictions, which also triggered supply chain bottlenecks.
• Increased demand fueled by the lifting of covid restrictions and the increased spending of cash reserves piled on during the pandemic, which meant customers returned to malls, restaurants, and so on (increasing demand) whilst supply remained low.

The Federal Reserve is taxed with the dual mandate of “stable prices” and “maximum employment.” The institution, which serves as the central bank of the US, could deploy several mechanisms to carry out a monetary policy, including hiking or decreasing interest rates. It does the former when the economy is “unsustainably hot” and needs to cool off, while the latter is when the economy is sluggish and needs a shot in the arm.

In this scenario, the Fed is increasing rates to cool off inflation. Usually, when that happens, it’s more expensive to borrow money. That reverberates in the entire economy, making it, for example, less attractive to take out loans because they come with a higher price tag. In the end, people end up spending less, and that has the effect of reducing inflation.

Bitcoin’s Correlation With Stocks

The Fed hikes have thrust something else to the fore once again: the correlation between crypto and stocks. Bitcoin is increasingly moving in tandem with stocks, especially with Fed rate increases. As crypto becomes more entrenched in the financial system, more investors have taken it up and treated it as they do stocks. For that reason, Bitcoin is finding itself with the same market movements as the traditional investment options.

This is worrying because Bitcoin is supposed to be a hedge against inflation and a depreciating dollar. The currency’s investors once took pride in their digital gold independent of the price dynamics of other asset classes. Yet, real gold has remained a haven for thousands of years regardless of market upheavals.

Putting It All Together

Things could have gone haywire after the Fed’s latest interest increase, but Bitcoin’s price behavior is the complete opposite after the fact. That’s due to something even Bitcoiners didn’t have in their crystal ball: bracing for the worst. And if the latest round of quantitative tightening has reminded the community of something else, it’s that their favorite cryptocurrency is taking cues from the stock market. Whether that will change or not remains to be seen.