Fed tightening begins as US macro outlook shifts
The war in Ukraine remains a key focus
China’s covid outbreak and policy response bear monitoring for crypto
This week the Federal Reserve began its well flagged tightening cycle, raising the federal funds target rate 25 bp (basis points) to 0.25%-0.50% and signaling that policy rates are expected to rise another 225 bp by the end of 2023. Those rate hikes will run alongside a steady reduction in the Fed’s balance sheet, which the central bank indicated would likely start in the coming months.
Adding to the hawkish tone of the policy meeting was Fed Chairman Powell’s emphasis on getting inflation under control, as persistently high inflation (the latest CPI printed 7.9%) would have more damaging economic effects in the long run.
Bitcoin took the Fed’s relatively hawkish messaging in stride and rose modestly in the wake of the FOMC meeting, while risk assets more broadly responded well. The positive reaction is partly due to the fact that interest rate markets have already priced in much of the policy rate hikes that the Fed signaled. Moreover, reduced uncertainty about key market drivers such as Fed policy is often a welcome development in financial markets.
Economic risks are building
That said, the macro backdrop in the US and globally still leave much for bitcoin investors to consider. Among them is whether Fed tightening will be so aggressive as to tip the US economy into recession.
A very tight labor market and the ability of consumers to draw down on savings accumulated during the pandemic suggests the economy should be fairly resilient. But market signals such as a flattening yield curve indicate that the risk of a more problematic slowdown in growth is increasing.
In addition to Fed tightening, the economy also faces a drag from higher energy / commodity prices, diminished fiscal stimulus and potential ripple effects from the war in Ukraine. As expectations about future US growth evolve in the coming months, financial assets – including crypto – will be sensitive to those gyrations.
Perhaps more directly, the Fed is intent on withdrawing a sizeable portion of the massive liquidity they injected into the financial system and economy since the start of the pandemic. That process will pose some challenges to bitcoin and other digital assets which benefited from the liquidity build over the past two years.
Ukraine war continues
As noted above, the war in Ukraine poses a material threat to global growth. Press reports this week indicating that Russia and Ukraine were discussing a possible end to hostilities were noteworthy and provided support to risk assets including crypto.
As welcome as a cease fire would be from a humanitarian perspective, the prevailing pattern has been one of negative developments and suggests caution towards headlines suggesting a more positive turn. The war will clearly remain a key focus on a host of levels.
Last week we observed that some recent demand for bitcoin could be related to its use in fund raising and transfers of relief funds into Ukraine. It is not clear if those flows are having a significant impact on the price. But they do highlight a most welcome and constructive use case for digital assets, with the speed and ease of those transfers/donations showing advantages over traditional financial networks.
Perhaps in recognition of that utility, this week Ukrainian president Zelenskyy signed into law a bill that establishes a legal framework for the country to operate a regulated crypto market.
China’s new CoVid wave
China is now dealing with what appears to be the worst CoVid outbreak since the pandemic began over two years ago. China’s “zero CoVid” policy is once again seeing lock downs in major cities, a development that if sustained could pose a real risk to economic growth, and Chinese financial markets fell dramatically early this past week.
To help counter the market volatility, China’s official news agency Xinhau reported that “China’s State Council vows to keep stock market stable,” which helped financial markets start to recover some of their losses.
These developments need to be monitored going forward as changes in China’s macro backdrop – whether via CoVid of other factors – can have a significant impact on the demand for and trading of bitcoin and other digital assets.