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How the Fed helped spark the last crypto bull run, and the bear market

how-the-fed-helped-spark-the-last-crypto-bull-run-and-the-bear-market

 

 

Last month, the Federal Reserve hiked interest rates by a half-percentage point, something the world’s largest central bank hadn’t done in over two decades. The reason? To rein in four-decade-high inflation that was driven, in part, by the unprecedented actions the Fed took two years earlier to stabilize the economy during the onset of the Covid-19 pandemic. But how did the Fed make such drastic moves in seemingly opposite directions, just two years apart? And what does that mean for the economy as inflation continues to spike? Let’s take a closer look.

  • The Fed’s main objectives include maintaining stable prices and maximum employment, while keeping credit flowing in the financial sector. One of its primary ways to manage all this is setting interest rates, which determine how cheap (or expensive) it is to borrow money. In 2020, when the Covid-19 pandemic shut down everything from businesses to schools, the Fed intervened to keep the economy afloat by cutting interest rates to zero, a move that eased lending rates between banks. Resulting low-interest mortgages and loans for things like cars and small businesses meant consumers remained active in the market despite the pandemic’s economic shock.
  • The Fed also supported pandemic-era financial markets with a process known as quantitative easing, which involved buying Treasury securities and mortgage-backed securities in order to inject liquidity (cash) into markets — a.k.a. printing more money. As a result, the Fed’s balance sheet has more than doubled to $8.95 trillion since early-March of 2020. This abundant liquidity, or “easy money,” ultimately helped buoy the economy, and also boosted riskier assets like tech stocks and crypto with excess consumer cash.
  • One of the downsides of all that extra cash? Inflation. Amid strong job growth and higher consumer demand, the U.S. Consumer Price Index (CPI) — which measures the annual rate of inflation of key categories like housing and food — jumped 8.6% in May, the biggest spike in 41 years. Economists attribute the surge in prices to several factors: increasingly strained global supply chains; economic fallout from Russia’s invasion of Ukraine and China’s ongoing Covid lockdowns; and the government’s $1.9 trillion Covid stimulus package.
  • Now, the Fed is focused on quantitative tightening, or withdrawing liquidity from financial markets by shrinking its balance sheet. This month, the central bank has started reducing its pandemic-era Treasury securities holdings and plans to accelerate those efforts in September. Meanwhile, the Fed is targeting interest rates between 0.75% and 1.00% (making borrowing money more expensive), and Fed Chairman Jerome Powell has signaled plans to keep increasing that number this year, perhaps as early as this week. One early indicator on how these efforts are impacting consumers: Mortgage demand has fallen to a 22-year low as home loans grow more expensive and home sales slow.

 

Why it matters… The Fed’s tightening measures, along with geopolitical concerns, have had a dampening effect on financial markets, pressuring stocks and crypto as investors move away from riskier investments. But some analysts have expressed concerns that efforts to stem inflation could tip the U.S. economy into a recession. So can the Fed pull off its much-referenced, tricky “soft landing?” As the chief U.S. economist at JPMorgan puts it, “The Fed has to thread the needle … We can avoid a recession, but we definitely have an elevated risk of one.”

 

Source Coinbase.com

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