Sophia’s Thoughts On The Fed’s New Action Plan
The macroeconomic mood appears to be shifting in the US after inflation came in hotter than expected and the Fed hinted they may not cut rates soon. What does this all mean for crypto?
These are Sophia's Thoughts:
After three consecutive months of higher-than-forecasted inflation, investors are on edge about what the Fed may do next.
The Fed Chair Jerome Powell insinuated that rate cuts may not occur anytime soon, even though the market had expected rates to start declining by June.
The new uncertainty as to when the Fed will cut rates poses challenges for investors, who are at a crossroad deciding whether to increase or reduce their exposure to risky assets.
For crypto in particular, this means that it is likely that we may continue to see a slowdown of the inflow of institutional capital into the market, removing a key support for recent crypto valuations.
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📊 The Fed’s Rate Cut Path
At the close of last year, financial markets were buoyed by the belief that the Federal Reserve might lower interest rates early in 2024. This sentiment was driven by a series of positive economic data and a calming inflation rate suggesting that the economy was on a path to recovery without overheating.
The release of the January, February, and March CPI reports introduced a new set of variables. January’s report showed an unexpected uptick in inflation. This pattern persisted into February, albeit with some moderation, yet not to a degree that shifted the overall trajectory. March further extended this pattern which suggested that inflationary pressures were not diminishing as anticipated. As a result, there is a prevailing consensus that rate cuts may be postponed or lessened until inflation cools off.
⚠️ Current Outlook
As it stands, the Federal Reserve remains committed to a cautious approach toward rate adjustments amid ongoing economic complexities. Recent statements from Powell highlight the current economic landscape:
“More recent data shows solid growth and continued strength in the labor market, but also a lack of further progress so far this year on returning to our 2% inflation goal.”
Strong employment and consumer spending despite high rates and inflation presents a unique set of challenges for monetary policy. The goal remains to achieve a ‘soft landing,’ which involves cooling economic growth and reducing inflation without precipitating a recession. Reflecting on this delicate balance, Powell commented:
“I have always felt since the beginning, that there was a possibility — because of the unusual situation — that the economy could cool off in a way that enabled inflation to come down without the kind of large job losses that have often been associated with high inflation and tightening cycles. So far, that’s what we’re seeing. That’s what many forecasters on and off the committee are seeing.”
However, Powell also conveyed caution about the path ahead, emphasizing the need to maintain current monetary restrictions: “Policymakers will maintain the current level of restriction for as long as needed until price pressures are tamed.” He further elaborated on the ongoing challenges, stating:
“The recent data have clearly not given us greater confidence, and instead indicate that it’s likely to take longer than expected to achieve that confidence. That said, we think policy is well positioned to handle the risks that we face.”
Achieving a soft landing is complicated by the timing and magnitude of rate adjustments. This is made more difficult by mixed economic indicators and the impact of global economic uncertainties and domestic fiscal policies. Powell’s cautious stance conveys this complexity, highlighting the careful navigation required by the Fed in the coming months.
🏦 Why does this matter for crypto?
Higher interest rates have raised the yields on safer assets like government bonds. Such market moves often draw investors away from riskier assets such as cryptocurrencies.
Top Barclays Banker Says ‘Rapid’ Flight From Risk Will Endure (Bloomberg)
Pension Funds Are Pulling Hundreds of Billions From Stocks (Wall Street Journal)
Wave of Cash Seen Washing Into Credit as Investors Seek Duration (Bloomberg)
For instance, pension funds and other large investors have been reallocating assets by moving from equities to bonds. The California Public Employees’ Retirement System (CalPERS) has reduced its target stock allocation from 42% to 37%. They are moving into private equity and private debt, expecting these asset classes to yield 7% to 8% over the next two decades. Similarly, the New York State Common Retirement Fund is decreasing its stock allocation to 39% from 47%, opting instead for private equity, real estate, and real assets.
The most significant risk for cryptocurrencies lies at the intersection of high inflation and shifting consumer sentiment. If inflation remains elevated, it may deter further investment in crypto, particularly from institutional players who are just beginning to engage with this asset class following recent ETF approvals.
For instance, Zorast Wadia, a principal actuary at Milliman, emphasized the cautious stance of pension funds: “You don’t want to give away all of those hard-earned gains.” This conservative approach alongside high rates means that investors are increasingly moving away from high-risk assets towards lower-risk assets. This may impact the flow of institutional money into the crypto market. We may already be experiencing the first signs of such a risk-off move. In recent weeks, the inflows into the spot Bitcoin ETFs that were just approved by the SEC has slowed down.
Higher interest rates and a shift toward more conservative investments by major institutional players could pose challenges for the crypto market, which thrives on risk-tolerant capital inflows. Stakeholders in the crypto industry will need to closely monitor these developments and perhaps adjust their strategies accordingly.Do you want to stay up-to-date on the latest crypto intelligence? Use the offer code ILxYOU to join Indicia Labs for free.
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