The mighty bear market of 2022 in the crypto markets was also caused by the monetary policies of the Fed, which is the US central bank.
However, this dynamic may change throughout the year.
To tell the truth, even behind the mighty bull run of 2021 there was perhaps, in part, the Fed’s hand, as it literally flooded the financial markets with huge amounts of dollars created out of thin air.
At that point, when it stopped doing so in March 2022, the markets reacted negatively, and not only the crypto markets. What’s more, in April of the same year they also started raising interest rates, raising them in a single year from 0.25% to 5%.
So both the performance of traditional financial markets and crypto markets over the past three years have been heavily influenced by the Fed’s monetary policies, which were very different from those of previous years.
Fed: the first change of course and the fall of crypto and traditional markets
After deciding in March 2020 to kick off the largest expansionary monetary policy campaign in decades, the next change of course was decided in early 2022.
Not surprisingly, crypto markets reached their all-time highs in late 2021, while for traditional markets the peak occurred between late 2021 and early 2022.
And not coincidentally, after the turnaround, the rest of 2022 was terrible for both crypto and traditional markets.
It is quite clear that drastic and important decisions such as those made by the Fed in March 2020, and in March 2022, have had decidedly very significant impacts on financial markets, so much so that in the event of a further change of course, a somewhat similar reaction is to be expected.
Inflation in the United States
Given that right now the pace at which the Fed is withdrawing the huge amount of dollars issued between 2020 and 2021 from the markets is not particularly significant, what matters most is the policy on interest rates.
It is worth mentioning that in February 2020 the Fed’s balance sheet was just over $4.1 trillion, while by March 2022 it had risen even above $8.9 trillion.
Since then it has only been reduced to 8.300 in early March 2023, but due to the collapse of some major US banks they were forced to bring it back above 8.7 trillion. It is now down to 8.6 trillion, which is still significantly higher than just over a month ago.
Instead, interest rates have continued to rise.
While at the beginning of the year they were at 4.5%, in February they were raised to 4.75%, and in March to 5%.
The reason is due to inflation, which is still very high.
Indeed, since July of last year, inflation in the US has been falling, but it still remains very high.
Whereas in June 2022 it even exceeded 9%, in March 2023 it dropped to 5%, which is much less than in June last year, but it is much more than the target of bringing it back to around 2%.
In order to have inflation continue falling so significantly – the one in March was the largest single monthly decline post-pandemic – the Fed decided to keep interest rates very high. Indeed, it is worth recalling that these are the absolute highest rates in decades.
However, March’s sharp drop in inflation, followed by another major drop in February, seem to show quite clearly that the current restrictive monetary policy of mainly very high rates is working.
In fact, there is a persistent speculation circulating that by the end of the year inflation in the US may return to a tolerable 3%, which in fact as of today does not seem that far from the current 5%.
Will there be a second change of course by the Fed? How might the crypto sector respond?
The question now is, when will the Fed opt for a second change of course, after the one in March 2022?
In reality right now the markets are giving it as likely that it will not happen before June. In fact, an additional 25 basis point interest rate hike in early May is still being given as likely.
So over the medium to short term, a second Fed policy change does not seem particularly likely.
However, the situation changes if the medium to long term is taken into consideration.
Indeed, markets may see a first 25 basis point rate cut as early as July, followed perhaps by another in November.
In other words, the hypothesis being reasoned about is another minimal increase in May, followed by two minimal reductions by the end of the year, which should end the year with rates at 4.75%, or lower than the current 5%.
The impact of Fed decisions on the crypto markets
If the actual scenario were to be just that, even though there is no certainty that it could come true, crypto markets could react by following the traditional ones.
The hypothesis that can be pondered is that until June things could continue more or less following the current trend, but from July to the end of the year they could change, perhaps for the better.
Then again, the not so positive reaction of the markets yesterday to the good inflation data also leaves room for another hypothesis.
Indeed, for a few days now the focus has been shifting from inflation to recession.
By now, the Fed’s monetary policy seems to be effective in fighting inflation, so much so that the hypothesis circulating is that it will fall to 3% by the end of the year. Markets are trying to see past the evidence, which is why they seem to be losing interest in a relatively clear-cut scenario such as this.
The focus seems to have shifted to the risk that the US could go into recession by year-end.
In this regard, and for the sake of the record, it should be specified that both the Fed and the US government say that they do not consider this scenario particularly likely as of today.
But these are statements that may also have propaganda purposes, and they are certainly biased.
In other words, it is not necessarily objective reasoning that is really suggesting that the risk of a recession is low.
Rather, there are economists and analysts who think a recession is very likely. Then again, historically after a prolonged period of high interest rates, a recession has almost always been triggered.
At this point, it seems possible that the Fed may decide, as soon as it can, to start lowering rates, precisely to avert a recession.
Should the downward trend in inflation support this decision, the financial markets could react well, and with them the crypto markets.
However, if a recession were to come, the reaction would have to be negative, and the gains made so far in these first three-plus months of 2023 could be lost.