Fed Rate Cuts: A Boon for Bitcoin Bulls, With a Twist

• Federal Reserve's Possibly Upcoming Rate Cuts Could Indicate Economic Recession
• The Catch in the Upcoming Rate Cuts
• Effects of a Recession
• Historical Precedent: Recession Following Rate Cuts?
• Skepticism Over U.S. Economy's Ability to Avoid Recession

Federal Reserve's Possibly Upcoming Rate Cuts Could Indicate Economic Recession

According to the minutes from the Federal Reserve's December meeting, there is a strong likelihood of interest rate cuts taking place in 2024. It has been suggested that these reductions could prove beneficial for bitcoin (BTC), especially when combined with other pivotal events such as the impending launch of the spot ETF and the four-yearly reward halving of Bitcoin$42,260 -0.64% blockchain's mining.

The Catch in the Upcoming Rate Cuts

However, previous data provided by MacroMicro indicates that the Fed's rate cut cycles usually begin when the economy is on the cusp of a recession. Thus, it's common to witness a brief and significant rally in the U.S. dollar, the global reserve currency backed by the world's largest and most liquid government bond market, during the early stages of these cycles.

This suggests that, based on historical patterns, bitcoin may experience a brief period of intense risk aversion later this year once the Fed begins lowering the benchmark Federal Funds rate.

Effects of a Recession

A recession is an extended period of decreasing economic output, coupled with a rise in unemployment. If market forces are left unchecked, a recession could lead to a steep drop in investors' willingness to take risks, resulting in asset price deflation. Central banks often use monetary stimulus to counteract this.

The dollar, being a global reserve currency, plays a significant role in global trade, international debt, and non-bank borrowing. Hence, a rally in the greenback can result in higher debt service costs for those who have borrowed in dollars. This could lead to tighter financial conditions, prompting investors to decrease their exposure to risk assets like bitcoin.

Historical Precedent: Recession Following Rate Cuts?

Historically, the Fed has turned to rate cuts when a recession seems imminent, leading markets to treat such cuts as a sign of impending economic trouble and to seek safety in the U.S. dollar. Data compiled by investment banking firm Piper Sandler indicates that recessions have consistently followed the onset of easing cycles over the past six decades.

The Fed tends to maintain high-interest rates for longer than necessary, inadvertently stifling economic growth. By the time rate cuts are implemented, the economy is typically in visible decline and unemployment is on the rise, often making a recession unavoidable, Piper Sandler pointed out in a communication to clients on January 2.

The firm also suggested that the same pattern is likely to repeat itself, with the Fed maintaining an unnecessarily long hawkish stance.

Skepticism Over U.S. Economy's Ability to Avoid Recession

Some market observers believe that the market is currently overestimating the U.S. economy's ability to stave off a recession following the steep Federal Reserve rate hike cycle which saw borrowing costs soar 525 basis points to 5.25% in the 16 months leading up to July 2022. Should this be the case, it may pave the way for a negative market reaction if a recession arises.

Edited by Jonathan Stoker