Fed Hawkishness dampens Crypto Market Momentum?

Federal Hawkish Stance Dampens Cryptocurrency Market Momentum?

Recently, the market generally expects a shift in US monetary policy towards tightening, and Fed Chairman Powell’s statement over the weekend has once again added uncertainty to this expectation. Powell said that the Fed may have more work to do in combating high inflation. “The Federal Open Market Committee (FOMC) is committed to achieving a fully restrictive monetary policy stance to gradually bring the inflation rate down to 2% over time; we are not confident that we have already achieved this.”

In recent days, the market has also been digesting “hawkish news”. In terms of monetary policy regulation, if the Fed continues to raise interest rates, it will directly increase US dollar interest rates and make US dollar assets more attractive. Meanwhile, the price of Bitcoin has dropped after reaching a peak on November 10th.

The US dollar, as the major global reserve currency and the dominance of the United States in the global economy, coupled with many assets being priced in dollars, gives the Fed influence in global financial markets, especially in developed countries’ markets and their reactions to Fed policies. However, internal inconsistencies in the Fed’s strategies led to misjudgments in the market between June and August this year. Some market participants mistakenly believed that the Fed had reached the peak of the rate hike cycle, resulting in a significant rebound in risk markets.

With institutional involvement and regulatory compliance, the crypto market, including Bitcoin, cannot be ignored. So, what is the correlation between Bitcoin and the Fed? Does this “niche market” still possess its unique safe haven characteristics?

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Connectivity Between On-chain and Off-chain, Greater Sensitivity in Crypto Market

Although cryptocurrencies such as Bitcoin are considered niche assets, their correlation with financial markets such as the S&P500 and global developed country stock markets has been increasing since 2020. We can see that in the correlation with major global stock markets (Equity F), the previous 0 correlation has changed to 0.25, which is only lower than the correlation of 0.29 with the S&P500. In terms of financial factors (Financials F), the correlation has changed from -0.03 to 0.19.

Source: IMFNote: Smart C. = Smart Contract, F = Factor

According to the estimation results of an IMF working paper, the impact of US monetary policy on the cryptocurrency cycle is almost the same as its impact on the global stock market cycle, which is in stark contrast to the potential of cryptocurrencies in hedging market risks. When the Fed’s monetary policy rate (SFFR) rises by one percentage point, the cryptocurrency factor decreases by about 150% of the subsequent decline in the stock factor over the next 15 days. This means that the crypto market is more sensitive to changes in the Fed’s monetary policy.

However, investors should also pay attention to the internal situation of the Federal Reserve. Currently, there is a divergence between the market and the Federal Reserve. The market generally believes that the United States is either at the peak of the economic cycle or in a normal inflation stage. However, despite the Federal Reserve’s insistence that the United States is facing the peak of the economic cycle or normal inflation, its actual actions and measures are more aggressive. Therefore, the market has some doubts about the Federal Reserve’s inconsistent stance.

Whether it is regulatory blessings, institutional acceptance, or the conclusions drawn from data, it is clear that the encrypted market is no longer niche. The encrypted market has become integrated into the global financial cycle.

Institutional entrance impact, encrypted investors need a macro perspective

With institutional funds flowing into the encrypted market, the maturity of the market will increase. At the same time, professional investors usually pay more attention to macroeconomic factors and changes in monetary policy. The increased participation of institutional investors strengthens the transmission effect of monetary policy on the cryptocurrency market. This will increase the impact of the Federal Reserve’s monetary policy on the market.

Arthur Hayes also pointed out in his latest article “Bad Gurl” that the bull market in the cryptocurrency market may come with the increase in USD liquidity, which is directly related to USD monetary policy. Therefore, from the perspective of the real economy and the global financial cycle, especially in predicting the actions of the Federal Reserve in advance, managing “managing market expectations” will become one of the most important criteria for future market investors.

In addition to the inconsistency in the internal stance of the Federal Reserve causing market doubts, we also need to pay attention to the external effectiveness of the Federal Reserve’s monetary policy. Investors need to have a broader macro view, such as referring to the dynamics of the real economy cycle and the overall environment of global financial operations. Taking into account factors such as the relative decline of the US dollar’s international status, the internationalization process of the renminbi, and the lack of clear advantages of the US GDP compared to the overall EU, scholars such as Professor Scott Sumner discuss the disproportionate impact of US monetary policy on the world nominal economy and propose the difference in influence between “nominal superpower” and “actual superpower”.

Cryptocurrencies such as Bitcoin are heading towards a new stage. With the participation of important stakeholders from institutional investors to regulatory agencies, the encrypted market is accumulating scale and influence at an unprecedented pace. At the same time, its price trend seems increasingly difficult to stand alone. In the short to medium term, even though the encrypted market has the blessing of technology, independent market trends are a thing of the past. Compared to stock market investors, cryptocurrency investors also need to pay attention to the trend of inflation, financial stability, and economic recovery from a more macro perspective under the challenges of multiple difficulties in formulating monetary policy.

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