Original author: Huo Huo
On August 5, the Bank of Japan's interest rate hike triggered a violent shock in the global financial market. Japanese and US stocks collapsed, the Bitcoin panic index in the crypto market soared by nearly 70%, and many stock markets in various countries were circuit-breakers. Even European and emerging market stock markets also suffered a significant blow. Under the huge market pressure, people began to seek a good way to alleviate the situation and called on the Federal Reserve to cut interest rates to save the market. The Fed's interest rate hike may come soon, which means that a "bigger" rate hike than the Bank of Japan is coming. Can it pull Bitcoin back to the bull market?
Why does the Federal Reserve have such a great influence?
1) What is the Federal Reserve?
Before understanding the concept and impact of the Fed's interest rate hikes and cuts, we first need to know what the Fed is.
The Federal Reserve is the central banking system of the United States, consisting of 12 regional Federal Reserve banks. Its goal is to stabilize prices and maximize employment by regulating monetary policy. Indicators such as inflation and employment are crucial to economic health, and are closely watched by investors and market participants to judge economic prospects and investment risks.
As the central bank of the United States, the Federal Reserve has a huge influence on the financial market. So how does the Federal Reserve exert its influence? It mainly affects the economy by adjusting interest rates through the following monetary policy tools, that is, raising or lowering interest rates:
Raising interest rates means raising the cost of borrowing between banks, thereby raising the interest rates that commercial banks charge for lending to businesses and individuals: When the Fed raises interest rates, the deposit rate on the US dollar rises, and depositors receive higher interest income, which leads to capital inflows into the United States, reducing investment in other countries, worsening the economic environment, and rising unemployment. High interest rates also increase borrowing costs, leading to an increased risk of default for businesses and individuals, which may trigger corporate bankruptcies.
Lowering interest rates does the opposite, reducing deposit rates and borrowing costs: When the Fed cuts interest rates, U.S. dollar deposit rates fall, capital flows out of banks and flows to other countries, promoting global investment and economic recovery.
So how many times has the Federal Reserve cut interest rates before? What impact did each have?
2) History of interest rate cuts
Looking back at history, the Federal Reserve has experienced six rounds of relatively obvious interest rate cuts since the 1990s. In terms of patterns, there were two preventive interest rate cuts, three bailout interest rate cuts, and one mixed interest rate cut that combined preventive interest rate cuts with bailout interest rate cuts.
First, let’s clarify the differences between these types of rate cuts:
Preventive rate cuts refer to the monetary authorities taking forward-looking policies to adjust interest rates when the economy shows signs of a downturn or faces potential external risks, in order to reduce the risk of recession and promote a "soft landing" of the economy. Features include: a shorter rate cut cycle, a moderate first rate cut, a limited number of rate cuts, and the federal funds rate will not fall below 2%.
Relief-style interest rate cuts are continuous and substantial interest rate cuts taken by monetary authorities when there is a threat of severe economic recession or a major shock, aimed at helping the real economy and residents, avoiding severe recession and promoting economic recovery. Features include: a long interest rate cut cycle (may last 2-3 years), a steep interest rate cut (may be continuous and substantial interest rate cuts in the early stage), a strong first interest rate cut (usually more than 50 basis points), and a large total interest rate cut (the final interest rate falls below 2% or close to zero).
In contrast, the hybrid interest rate cut cycle is more complicated. It may appear as a conventional preventive interest rate cut in the early stage, but due to the rapid change of the situation, it may turn into a relief-style interest rate cut in the later stage.
So what impact have these notable cycles of interest rate cuts by the Fed since the 1990s had on markets and the economy?
1990-1992:
Rate Cuts: During this cycle, the Fed lowered the federal funds rate from 9.810% to 3.0%.
Market impact: This round of rate cuts helped support the economy's recovery from the 1990 recession. Stocks began to rise during this period, economic growth gradually resumed, and although inflation and unemployment remained under pressure, overall economic conditions gradually improved.
1995-1996:
Rate Cuts: The Federal Reserve began cutting interest rates in 1995, lowering the federal funds rate from 6.0% to 5.25%.
Market impact: This round of rate cuts was primarily intended to counter the slowdown in economic growth, supporting stock market gains and economic stability. This phase marked a continuation of economic expansion, with strong stock market performance, particularly benefiting technology stocks, which was followed by the tech boom of the 1990s.
1998 (September - November)
Rate cut: The federal funds rate was reduced from 5.50% to 4.75%.
Market impact: It eased market tensions and supported economic growth. The rate cut had a positive impact on the stock market, especially technology stocks, which rebounded strongly. The Nasdaq index rose sharply in 1998, laying the foundation for the subsequent boom in technology stocks.
2001-2003:
Rate Cuts: During this cycle, the Federal Reserve cut interest rates from 6.5% to 1.00%.
Market impact: This rate cut was made after the 2001 recession. The rate cut helped support the economic recovery and boosted the stock market in 2002 and 2003. However, the excessive relaxation of this round of rate cuts also laid the groundwork for the subsequent real estate bubble and financial crisis.
2007-2008:
Rate Cut: The Federal Reserve cuts interest rates from 5.25% to near zero (0-0.25%).
Market impact: This round of interest rate cuts was to respond to the severe impact of the 2008 financial crisis. The low interest rate policy effectively eased the pressure on the financial market, supported the recovery of the economy and financial markets, and promoted a strong rebound in the stock market after 2009.
2019-2020:
Rate Cuts: The Federal Reserve cut interest rates from 2.50% to near zero (0-0.25%) in 2019 and 2020.
Market impact: The interest rate cuts were initially intended to respond to the economic slowdown and global uncertainty. After the outbreak, further interest rate cuts and large-scale monetary stimulus helped stabilize financial markets and support economic recovery. The stock market experienced a rapid rebound in 2020. Although the epidemic caused a severe economic shock, policy measures mitigated some of the negative impact. This round of interest rate cuts also indirectly contributed to the occurrence of the Crypto 312 incident.
It can be said that each interest rate cut cycle has different impacts on the market and the economy, and the formulation of interest rate cut policies will also be affected by the current economic environment, market conditions and global economic situation.
3) Why does the Federal Reserve have such a great influence?
The Federal Reserve has a huge impact on the global financial market, so its policies directly affect global liquidity and capital flows. The specific influence is reflected in the following points:
Global Reserve Currency: The U.S. dollar is the world's main reserve currency, and most international trade and financial transactions are denominated in U.S. dollars. Therefore, changes in the Federal Reserve's monetary policy will directly affect the global financial markets and economy.
Interest rate decisions: The interest rate policy of the Federal Reserve has a direct impact on the interest rate level of the global financial market. The Federal Reserve's interest rate hikes or cuts will lead other central banks to follow suit and adjust their policies. This interest rate transmission mechanism makes the Federal Reserve's policy decisions have a profound impact on global capital flows and financial market trends.
Market expectations: The Fed’s comments and actions often trigger fluctuations in global markets. Investors pay close attention to the direction of the Fed’s policies, and the market’s expectations of the Fed’s future policies will directly affect asset prices and market sentiment.
Global economic linkage: As the global economy is highly interconnected, the economic situation of the United States, as the world's largest economy, also has an important impact on the economies of other countries. The Federal Reserve regulates the U.S. economy through monetary policy, which also affects the trend of the global economy.
Risk asset price fluctuations: The Fed’s policy measures have a significant impact on the prices of risk assets (such as stocks, bonds, and commodities). The market’s interpretation and expectations of the Fed’s policies will directly affect the volatility of the global risk asset market.
In general, due to the importance of the U.S. economy and the global status of the U.S. dollar, the Fed's policy initiatives have a profound and direct impact on global financial markets, so its decisions are closely watched by global markets.
So what will be the intensity, speed and frequency of the upcoming Fed rate cut cycle? How long will the entire rate cut cycle last? How will it affect global financial markets?
How to view the Fed's current round of interest rate cuts
1) Expectations for this round of interest rate cuts
Entering the third quarter of 2024, there are signs in the US domestic market that monetary policy may need to be adjusted. Data such as unemployment rate, employment, and wage growth show that market activity has declined, the decline in technology stocks shows that economic growth has slowed, and the United States still has a huge amount of outstanding debt interest. All signs indicate that the Federal Reserve needs to cut interest rates to promote consumption, revitalize the economy, and over-issue currency. Before Black Monday, the market generally predicted that the Federal Reserve might start cutting interest rates as early as September this year.
According to market expectations, Goldman Sachs had previously predicted that the Fed would cut interest rates by 25 basis points in September, November and December, and pointed out that if the August employment report was weak, a 50 basis point cut in September was possible. Citigroup also predicted that interest rates could be cut by 50 basis points in September and November. JPMorgan Chase economists adjusted their forecasts, believing that the Fed could cut interest rates by 50 basis points in September and November, and mentioned the possibility of an emergency rate cut between meetings.
After Black Monday, some radical analysts believe that the Fed may take action before the September meeting, with a 60% probability of a 25 basis point rate cut, which is extremely rare and generally used to deal with serious risks. The last emergency rate cut occurred at the beginning of the epidemic.
However, there is still great uncertainty in the global economic trends, including the US economy. Major institutions have different views on whether this round of interest rate cuts is a preventive cut or a relief cut. The impact of the two on the market is also very different, and further observation is needed.
2) The possible impact of this round of Fed rate cuts
The Fed's rate cut expectations have begun to have an impact on global financial markets and capital flows. In order to cope with the downward pressure on the economy, the interest rate cut bets of the Bank of England and the European Central Bank are also heating up. Previously, some investors believed that the probability of the Bank of England cutting interest rates in September is now more than 50%. For the European Central Bank, traders expect two rate cuts by October, and the expectation of a sharp rate cut in September is not far away.
Next, let’s look at some of the possible impacts of this round of interest rate cuts:
A. Impact on the global market
The Federal Reserve's interest rate cut is expected to have a significant impact on global financial markets.
First, lower US dollar interest rates may prompt funds to flow to markets and assets with higher yields, leading to an increase in global capital flows.
A rate cut could also weaken the dollar, which could trigger exchange rate fluctuations and push up the prices of dollar-denominated commodities such as crude oil and gold. In addition, a weaker dollar could make U.S. exports more competitive, but it could also exacerbate international trade tensions.
At the same time, interest rate cuts may reduce borrowing costs for global stock markets, boost corporate profit expectations, and thus drive stock markets higher.
Lower international capital costs will encourage more investment, but will have limited impact on already highly indebted countries and companies.
Because although lower international capital costs will encourage investment, highly indebted countries and companies may find it difficult to use these low-cost funds for new investments due to debt pressure and strict borrowing conditions.
Finally, interest rate cuts could bring about global inflationary pressures, especially when currencies depreciate and commodity prices rise, with implications for economic stability and central bank policy.
B. Will interest rate cuts directly benefit the crypto market?
Although many people believe that interest rate cuts will increase market liquidity, reduce borrowing costs, and may push up cryptocurrency prices, and that in an environment of interest rate cuts, economic uncertainty will increase and investors may turn to safe-haven assets such as Bitcoin, there are also reservations that we need to be wary of potential economic recession risks.
However, many institutions generally believe that in a complex and volatile market environment, the market may also experience significant fluctuations during interest rate cuts. During the 2008 financial crisis, markets fell sharply after briefly peaking even as the Federal Reserve took early steps to cut interest rates. Although the Federal Reserve quickly and significantly lowered interest rates, it failed to effectively curb the spread of the crisis. The roots of the crisis can be traced to the subsequent bursting of the dot-com and real estate bubbles, which had a profound recessionary impact on the economy.
It remains to be seen whether the current interest rate cut policy will repeat the same mistakes and trigger an outbreak such as the artificial intelligence bubble or the US debt crisis, which will in turn drag down the crypto market.
However, in the short term, the interest rate cuts by global central banks, represented by the Federal Reserve, are a shot in the arm for the global financial market and the crypto market. There is no doubt that the expectation of interest rate cuts will directly promote the increase of market liquidity, trigger market optimism, and is expected to prompt the cryptocurrency market to usher in a wave of rising prices in the short term, bringing investors opportunities for quick profits.
In the long run, the trend of the cryptocurrency market will be affected by more complex and changeable factors, and price fluctuations are not just driven by a single factor, which requires a comprehensive analysis:
First, the market trend depends mainly on the strength of economic recovery. If interest rate cuts can promote economic growth, the cryptocurrency market may benefit; conversely, if the economic recovery is weak and market confidence weakens, cryptocurrencies will inevitably be affected. During the 2020 COVID-19 pandemic, Bitcoin was affected by the stock market and commodities and also experienced a 312 crash. Markus Thielen of 10x Research recently pointed out that the US economy is weaker than the Federal Reserve expected. If the stock market follows the decline of the ISM manufacturing index, the price of Bitcoin may continue to fall. In addition, investors may sell Bitcoin during economic downturns.
Secondly, inflation factors need to be considered. The central bank cuts interest rates to stimulate the economy and promote consumption, but it may also lead to inflation risks such as rising prices. Then rising inflation will in turn lead to the central bank raising interest rates, which will bring new pressure to the crypto market.
Third, the US election and global regulatory changes also have far-reaching impacts. Who will be the new US president? What policy the new president will adopt towards encryption is still unknown.
In short, the interest rate cuts initiated by central banks around the world have undoubtedly brought new opportunities and challenges to the crypto market. The interest rate cuts will most likely provide liquidity support for crypto assets in the short term, which includes factors such as increased liquidity and increased risk aversion demand. However, it also faces the lessons of historical financial crises and challenges from other complex factors. It is difficult to guarantee that it will be beneficial to the development of crypto for the time being.
summary
In general, this Black Monday was caused by concerns about the US economic recession, which led to the collapse of the market. In addition, industry giants were not optimistic about US economic prospects and global geopolitical turmoil. In the short term, these will keep the market in a period of policy fluctuations.
According to the cyclical laws of finance in the past, crises and opportunities are born together. Generally, economic downturns, market fluctuations and investment losses may bring anxiety and panic, but also provide investors and companies with opportunities to regroup and find innovative opportunities. At the same time, crises force companies to improve their business models and increase efficiency, so as to develop more steadily in the future.
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