The Relationship Between The US Federal Reserve's Interest Rate And The Bitcoin Exchange Rate

This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.
When we consider the factors influencing Bitcoin’s exchange rate, one in particular stands out – the key rate set by the US Federal Reserve. Understanding how this mechanism impacts the crypto market can help crypto investors to make the right decisions. 

The Key Rate and What It Affects 

The US Federal Reserve’s key rate is also described as the minimum interest rate at which commercial banks are able to borrow money from each other to ensure the mandatory level of reserves. By law, banks are required to maintain a certain level of reserves in accordance with the deposits they have. When a bank has excess reserves, it has the right to lend them to other banks. By the same token, banks that are lacking in reserves may borrow money from other commercial organizations. The reserves themselves are stored in the Federal Reserve System – a kind of central bank, in other words. Several times a year, members of the Board of directors of the US Federal Reserve meet and decide at what minimum rate commercial banks will be able to issue loans and borrow money from each other.

If the key rate is reduced, then the cost of money for commercial organizations is effectively reduced too. Following the key rate, the interest rate on loans and deposits also decreases. Loans, therefore, become cheaper, and deposits become less profitable. If the interest rate rises, the cost of money for the bank increases. Indeed, taking out loans becomes less favorable, but the profitability of deposits increases. 

The interest rate also affects the stock market. Indeed, an increase in the key rate also leads to an increase in the yield on new treasury-issued bonds, while the value of already-issued bonds with lower yields falls. For example, if the key rate is 1.5%, then the yield on government bonds is traditionally quite close to this level – let’s say, 2%. This means that the holder of such bonds receives a 2 percent annual income from the bonds. If the key rate rises to 3%, then new bonds are issued with a yield of about 3.5 - 4%. Meanwhile, the yield of those bonds that were issued at the previous key rate remains at 2%. Since old bonds are less attractive in terms of profitability, their value in the market is falling.

The key rate is effectively an instrument that has a direct impact on the country's economy. The lower the key rate, and subsequently, the cheaper the loans, the faster money rotates in the economy; the purchasing power of the population grows because they can take out cheaper loans from the bank, meaning businesses are able to grow faster. Of course, the latter is usually not possible without loans.

However, these advantages have a downside: cheap loans can increase inflation through an excess of aggregate demand. When the risks of inflation increase, the central bank may decide to raise the key rate, making loans less affordable, reducing consumer demand for goods, and slowing down industry growth. This will certainly slow down inflation, but will also lead to a slowdown in economic growth. Regulators around the world are constantly conducting this balancing act, raising and lowering the key rate as per economic indicators. 

The Key Rate and Bitcoin’s Exchange Rate

The connection between Bitcoin and the key rate’s level (in the United States) has intensified over the last five years, as American capital has become almost overwhelming in the crypto market. American investors – both retail and institutional – have used cryptocurrency investments to maximize their return on investments. Even stocks haven’t shown such growth, let alone Treasury bonds (with their less than 2 percent annual yield).

But, of course, there’s a rule that we’re forgetting. The diversification of an investment portfolio always assumes the presence of both high-risk (stocks, cryptocurrencies) and low-risk assets (bonds) in it. Indeed, if investors expect an increase in the key rate, then they expect an increase in the yield of low-risk bonds. This provokes an outflow of capital from high-risk assets, including cryptocurrencies, and from already issued bonds, whose yield in the future will be lower than the yield of new bonds issued with an increased key rate. Part of the withdrawn capital will then be invested into new bonds with a higher yield after the key rate increase.

This happened at the turn of 2021/2022 when the US Federal Reserve announced the acceleration of the reduction of the economic stimulus program and the key rate increases planned for 2022. The first of such reports from the Fed appeared in November 2021. Then, Bitcoin was trading at a level above $60,000. After reports of an imminent increase in rates, the cryptocurrency exchange rate began to decline and by January, the price fell below $ 40,000.

Bloomberg’s chief commodities strategist Mike McGlone called expectations of a key rate hike an "obstacle" and a "headwind" for the Bitcoin exchange rate. However, his positive assessment of the future of Bitcoin remained unchanged with the words "Bitcoin has already proved its value."

"Importantly, Bitcoin is not directly dependent on the key rate. On the one hand, if market participants expect a rate increase, its rate is under pressure. But on the other hand, the rate increase indicates that the regulator sees inflationary risks. Bitcoin, in recent years, has become in the eyes of American investors an alternative to gold, which is used to hedge inflation risks," emphasizes Nikita Soshnikov, Director at Alfacash. According to him, after each message about a possible acceleration of rate increases (and there have already been several in the first quarter of 2022), the volume of Bitcoin sales on his platform increased by 25-30% compared to the daily average.

On Alfacash Store, the users can buy and sell over 19 cryptocurrencies with EUR. The company says that it is one of the fastest and safest ways to trade digital currencies in the European Union, and is constantly improving its services. The platform offers SEPA transfers for incoming and outgoing payments with cryptocurrencies in a fully non-custodial, regulated, and automatic process. And while the platform might not be as popular as Binance and the likes, it supports most of the popular cryptocurrencies like Bitcoin, Ethereum, Ripple, USDC, USDT, DOGE, etc. Alfacash Store has set out to become the most convenient way for providing financial services to everyone regardless of their location.

To experience their advantages and more nice surprises for yourself, visit Alfacash Store now!

This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.