Investors’ risk appetite tends to increase with lower cost of capital and higher liquidity, creating a favorable scenario for high-growth assets. As a result, Bitcoin (BTC) and other cryptocurrencies often benefit from these situations because demand typically increases as more currency is in circulation. But since inflation in the US appears to be under control, why isn’t the cryptocurrency market reacting positively?
Interest rate cuts affect corporate performance and the real estate market
The US Federal Reserve (Fed) closely monitors the employment market, inflation, and the value of the USD currency and adjusts its policy accordingly. When the inflation trend approaches the Fed’s target of 2%, it provides the bank with the necessary capital, especially when the economy is weak, giving it room to lower interest rates and inject liquidity. This move, known as expansion, reduces the incentive to invest in bonds.
The latest reading for the Fed’s preferred inflation gauge showed inflation slowing in May, the slowest pace since March 2021 and the first time inflation has exceeded the Fed’s 2% target. The core personal consumption expenditures (PCE) index, which excludes food and energy costs, rose 2.6% in May from a year earlier, matching economists’ forecasts.
“It’s just further news that monetary policy is working and inflation is gradually cooling,” San Francisco Federal Reserve Bank President Mary Daley told CNBC’s Andrew Ross Sorkin. Additionally, the Bureau of Economic Analysis reported that personal incomes rose 0.5% monthly, exceeding expectations of 0.4%. Meanwhile, consumer spending rose 0.2%, slightly below expectations of 0.3%.
Earlier this year, market traders had expected at least three rate cuts. But expectations have now been adjusted to just two, expected to begin in September. “It would take further evidence of labor market easing, ideally combined with further deceleration in inflation, to pave the way for the first rate cut in September,” Seema Shah, chief global strategist at Principal Asset Management, told CNBC.
The S&P 500 hit a record high on June 28, driven by the latest US inflation data, a 4% unemployment rate, and rising personal income. However, overall cryptocurrency market capitalization has fallen from its 2024 high on March 14. Even gold, which is generally considered a hedge asset, is currently trading at just 5% below its May 20 all-time high.
Related: Bitcoin activity has fallen to its lowest level since 2010.
Cryptocurrencies tend to underperform when the US dollar is strong.
In theory, cryptocurrencies should benefit from the prospect of interest rate cuts and other expansionary measures due to their scarcity and irreproachable means of payment. However, the relative success of the Fed’s strategy strengthens the U.S. dollar, which can be measured against a basket of foreign exchange rates using the Dollar Strength Index (DXY). A higher DXY index means that the Euro, GBP and Swiss Franc are losing value.
Currently, the DXY index is hovering at 106, the highest since November 2023, and the US 5-year Treasury yield fell from 4.72% to 4.30% on April 25. This shows that investors are relatively confident in a ‘soft landing’. Where inflation decreases without a recession. In this case, traders are likely to expect the stock market to continue hitting new highs without any major shocks to the real estate market.
This hypothesis explains why low inflation has not had a positive impact on the cryptocurrency market. However, there is still uncertainty about how the economy and the U.S. dollar will behave if the Fed opts for an expansionary monetary policy. Therefore, the possibility of Bitcoin and cryptocurrencies rallying in late 2024 cannot be ruled out.
This article does not contain any investment advice or recommendations. All investment and trading activities involve risk and readers should conduct their own research when making decisions.