Investors’ appetite for risk typically increases when the cost of capital is low and liquidity is high. This creates a favorable environment for high-growth assets like Bitcoin (BTC) and other cryptocurrencies, as increased money circulation usually leads to higher demand. However, despite inflation appearing to be under control in the United States, the cryptocurrency market has not reacted positively. So, why is this the case?
Interest rate cuts have an impact on corporate earnings and the real estate market. The US Federal Reserve closely monitors factors such as the job market, inflation, and the value of the dollar to adjust its policies accordingly. When inflation approaches the Fed’s target of 2%, it allows room for interest rate reductions and injects liquidity by providing banks with capital, especially during economic weaknesses. This expansionary movement reduces the incentives for fixed-income investments.
The latest figures from the Federal Reserve’s preferred inflation indicator show a slowdown in inflation for May. Price increases during this period had the slowest growth since March 2021, marking the first time in this economic cycle that inflation exceeded the Fed’s 2% target. The core Personal Consumption Expenditures (PCE) index, which excludes food and energy costs, rose by 2.6% year-over-year in May, in line with economists’ predictions.
San Francisco Fed President Mary Daly noted in an interview with CNBC’s Andrew Ross Sorkin that “It is just additional news that monetary policy is working, inflation is gradually cooling.” The US Bureau of Economic Analysis also reported that personal income increased by 0.5% monthly, surpassing the expected 0.4%. However, consumer spending only rose by 0.2%, slightly below the anticipated 0.3%.
Earlier in the year, market traders anticipated at least three interest rate cuts, but current projections have adjusted to only two, expected to begin in September. Seema Shah, the chief global strategist at Principal Asset Management, commented to CNBC that “a further deceleration in inflation, ideally coupled with additional evidence of labor market softening, will be necessary to pave the way for a first rate cut in September.”
Despite the recent US inflation data, along with a 4% unemployment rate and personal income growth, leading the S&P 500 to reach an all-time high on June 28, the total cryptocurrency market capitalization has decreased since its peak on March 14. Even gold, which is typically considered a hedge asset, is currently trading only 5% below its all-time high from May 20.
In theory, cryptocurrencies should benefit from the prospect of interest rate cuts and other expansionary measures due to their scarcity and non-censorable payment methods. However, the relative success of the Fed’s strategy strengthens the US dollar, which can be measured against a basket of foreign exchange rates using the US Dollar Index (DXY). A higher DXY means that the euro, pound, and Swiss franc are losing value.
Currently, the DXY is hovering around 106, its highest level since November 2023, and the US five-year Treasury yield has decreased from 4.72% on April 25 to 4.30%. This indicates that investors are relatively confident in a “soft landing,” where inflation decreases without an economic recession. In this scenario, traders likely expect the stock market to continue reaching new highs without significant shocks in the real estate market.
This hypothesis explains why lower inflation has not had a positive impact on the cryptocurrency market. However, there is still uncertainty about how the economy and the US dollar will behave if the Fed chooses an expansionary monetary policy. Therefore, it’s not unreasonable to expect a rally for Bitcoin and cryptocurrencies later in 2024.
Please note that this article does not provide investment advice or recommendations. Every investment and trading decision carries risks, and readers should conduct their own research before making any decision.