Beyond Speculation: The FOMC's Implications for Bitcoin
Unpacking the Federal Reserve’s FOMC Outcomes and Bitcoin's Ascendancy as a Safe Haven Asset Amid Economic Uncertainty
The Federal Reserve’s Federal Open Market Committee (FOMC), the body that votes on monetary policy, met this week to decide their policy for the next six weeks. As expected, nothing changed. They held their Fed Funds target range at 5.25–5.5% and their rate of balance sheet reduction as is. Things were kept so steady that their policy statement was almost identical to January’s meeting, only removing six words from the first sentence and making no other changes.
Changes were revealed, however, in the press conference. Powell mentioned it may be appropriate to reduce the rate of balance sheet reduction as soon as the next meeting. Meaning their Quantitative Tightening (QT) policy is going to ease, so the first baby step toward cuts was announced. A new Summary of Economic Projections (SEP) also accompanied this meeting, in which members gave their estimates for the Fed Funds rate. The median of committee members’ estimates for the end of the year came in at 4.6%, the same as at the at the last meeting.
Source: Federal Reserve
The fact that the median projection is unchanged is a big deal because they only have six meetings left this year. On top of that, the market is currently not pricing in a cut at the next meeting in May. That leaves three cuts within five meetings if their cuts come in 25 bps steps. That is a significant pace if we are also to believe that the economy is doing fine.
Understanding the Neutral Rate
Much of the discussion about the Fed’s policy revolves around the idea of the “neutral rate” of interest. You might hear it called the “natural” or “equilibrium” rate as well. This is a theoretical interest rate at which monetary policy is neither accommodative nor restrictive. In this state, the economy is growing at its theoretical potential and inflation is stable, meaning the central bank's interest rate neither stimulates nor restrains economic growth.
This theoretical neutral rate guides Fed policy. Exactly two years ago, the Federal Reserve set out on the current cycle of hiking. Their goal was to reach a sufficiently restrictive policy that would tame the highest inflation in decades. The Fed Funds rate was hiked extremely rapidly and taken to an extraordinarily restrictive level in order to fight the extraordinary inflation. This was unusual because the Fed has a “dual mandate," stable prices, and maximum employment. By aggressively hiking, the Fed was sacrificing the maximum employment of half their mandate.
The Federal Reserve can only estimate the neutral rate based on the perceived results of their policies on their chosen measure of inflation, Core PCE in this case. However, the neutral rate itself is a theoretical concept, and relying on such an abstract metric to anchor their policy framework is precarious at best. It is a flimsy foundation for such critical policy decisions.
Giving up on Inflation?
There is a lot of confusion about why the Fed would cut rates this year if their inflation target of 2% is not met. I’ve seen numerous reports that the Fed is “given up” on fighting inflation. That is definitely not the case. Chair Powell has been crystal clear that their 2% target is not changing and that they are planning to bring their policy into more balance with regards to their dual mandate. In other words, they are going to start considering both halves of their mandate in their decisions.
I put together this little graphic to show what they are thinking. The “3% Neutral” is my own personal guesstimate, but remember, it is theoretical.
What should we take away from the FOMC meeting? First, they are not “giving up” on fighting inflation. In their minds, they will still be sufficiently restrictive if they cut as estimated. Second, they are not concerned about inflation reaccelerating. They are more concerned that the US will follow other major economies into recession, which is deflationary.
Lastly, the Federal Reserve has lost a lot of credibility, not only in their diagnosis of the economy but in their very monetary theories and tools. The market did not buy the optimistic language that “economic activity has been expanding at a solid pace.” Several times in the press conference, I found myself thinking, ‘That was a weak answer. Powell sounds unsure.’
The market, to a degree, relies on the Fed’s psychological policy to remain calm. This meeting did little to calm anyone’s fears. Those who think inflation will pick back up will interpret this as giving up on the inflation fight. Those who are already feeling a recession will think the Fed is going to act too late. Those who believe in the Fed’s omnipotence will come away questioning its credibility.
What the FOMC Means For Bitcoin
Amid inflation concerns, the looming specter of recession grows clearer. The Federal Reserve might not acknowledge it yet, but signs of an economic downturn are already evident in other major economies. Since the recent FOMC meeting, market behavior aligns with the notion that we're edging toward a recession, which could curb inflation fears, casting a potentially bullish light on Bitcoin.
Source: India Today
The introduction of ETFs has indeed opened doors for traditional investors to enter the Bitcoin market. However, Bitcoin's resilience amidst massive ETF outflows suggests its burgeoning identity as a safe haven asset, not just a speculatively risky one. It was the worst 3-day stretch since the ETFs launched (-$742 million), doubling the previous worst 3-day stretch from January 22–24 (-$350 million). Despite this record outflow, the price drop after 3 days has been less than in January and is holding in the ballpark of ATHs. That underscores Bitcoin’s evolving role in investors' eyes. This isn't solely about ETF-driven demand; it's about Bitcoin's perceived value in uncertain economic times.
Why is this distinction important? Many speculate that Bitcoin could face a significant downturn akin to the COVID-induced crash when the recession hits the US. Some investors might try to time the market, selling at perceived highs to buy back later at lows, while others may postpone entering the market until post-recession. However, Bitcoin's emerging status as a safe haven could defy these expectations.
Historically, assets like gold have served as robust deflation hedges, holding or increasing in value during economic downturns. Bitcoin, with its rapid response to market signals, could be challenging to time, unlike gold. Its accelerated reaction pace suggests that it might not only hold its ground but also potentially appreciate as we enter a recession. It has already risen as Japan, the UK, and Germany have entered recession.
In essence, Bitcoin is poised to continue its rise as the economic environment shifts towards a recession. It doesn’t matter that the Federal Reserve uses theoretical metrics if we experience higher-for-longer inflation or slide into a deflationary recession. Bitcoin’s performance, distinct from traditional risk assets, positions it alongside gold and Treasury securities, offering a new avenue for hedging against recession risks.
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