How is the interest rate hikes impacting the market?

Federal Reserve Chairman Jerome Powell recently confirmed that "the central bank will indeed raise rates in March, and that the high inflation such a hike is intended to combat will be prolonged."

Higher interest rates generally mean a lower appetite for high-risk/high-return assets such as cryptocurrencies. In theory, this should mean that the crypto market will experience declines in prices at various points this year, although increases are likely to be modest.

Still, with the stock market reacting badly to recent threats of hikes, and with the cryptocurrency market becoming increasingly correlated to stocks, crypto could be in for a bearish year because of the changing macroeconomic outlook.

How much of an impact will the interest rate hikes have on the market?

Looking at the recent market downturn, the rise in March and subsequent hikes could have a significant impact on Bitcoin and the wider cryptocurrency market.

Consequently, when the Federal Reserve met on January 26^th, BTC fell from about £30,924 to £28,964. This was a fall of about 6 per cent, and it came in less than 24 hours.

The Fed's negative impact on Bitcoin and crypto stretches back further. On January 5^th, the FOMC released its December 14-15 minutes, in which it indicated that it was likely to increase rates in 2022.

Following this publication, BTC sank from £37,864 to £35,176 in a few hours, before descending to £33,796 a couple of days later, representing a fall of around 10 per cent.

Since the January 5^th publication, BTC and crypto have been on a longer-term downward spiral, with the cryptocurrency market losing 21.7 per cent of its total value.

Blockchain Coinvestors CEO Lou Kerner said: "Tightening by central banks is the biggest macro issue driving both the stock and crypto markets today, which is why we are seeing a very high correlation between the markets."

Bitcoin and the cryptocurrency market, in general, climbed about 4 per cent following an announcement from the U.S. Federal Reserve that it would increase interest rates by 0.25 per cent marking the central bank's first such rate adjustment since 2018.

Following the announcement, the overall crypto market and Bitcoin went surprisingly higher to £1.48 trillion and £33,565, respectively, according to CoinMarketCap at press time.

The Fed further indicated that it plans to raise rates several times in 2022, representing a stark reversal to its loose lending and overgenerous efforts to print and pump U.S. dollars into the economy since the COVID-19 pandemic began two years ago.

Powell testified before the House Financial Services Committee in early March. He stated: "We need to move away from very low-interest rates. They are not appropriate for the current situation in the economy."

The central bank has planned three rises of 0.25 per cent each, suggesting that the Federal Reserve funds rate will reach 1 per cent. However, this is deemed as not a significant figure, particularly when compared to the effective rate in July 2019 which was 2.4 per cent and as high as 19 per cent in 1981.

Fed hopes rate hikes will slow record-high inflation.

The U.S. Bureau of Labour Statistics released data that showed the primary inflation gauge the consumer price index was up 7.9 per cent for February, marking the highest level in 40 years and the 10th straight month it was higher than 5 per cent.

In its official statement, the Federal Open Market Committee (FOMC) said: "Russia's invasion of Ukraine and that ongoing war could drive inflation higher in the short term."

The FOMC added: "The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The implications for the U.S. economy are highly uncertain, but in the near term, the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity."

The banking and crypto crisis

Since the failure of SVB and other banks, market prices have been gyrating between various forecasts regarding the next step in the Federal Reserve's monetary policy. While fears over a banking crisis have led to pricing a pause in interest rate hikes, traders now look for a 25 basis points raise in the central bank's meeting.

As a result, cryptocurrency prices could see limited price movements before the interest rate decision. However, it could be subjected to strong volatility afterwards. If it materializes, the hike could erase part of the latest gains as traders could move to safer assets while treasuries become even more attractive in terms of yields.

Regulators including the Federal Reserve have been cautioning lenders for months about the risks of dealing in digital assets. To crypto critics, those warnings sound prescient in the wake of the seizure of Silvergate Capital, Silicon Valley Bank and Signature Bank by the government. To crypto executives, they sound like trouble.

Chief strategy officer at stablecoin issuer Circle Dante Disparte said: "If banks are being told they cannot bank the sector, then how does the sector create diversification and banking?"

He added: "The risk, unfortunately, was too few banks banking too big a sector."

The banking turmoil is the latest setback for the crypto industry, which witnessed much of its value wiped out after the collapse of one of the largest crypto exchanges, FTX, and the indictment of its founder, Sam Bankman-Fried.

In recent years, Silvergate and Signature, especially, had become integral parts of the digital asset ecosystem by offering both traditional banking services as well as speedy payment networks. SVB had less exposure to the industry.

Former federal Reserve bank examiner Mark Williams said: "Yet not everyone is convinced that the banking crisis is heavily linked to the lenders' ties to crypto. Ultimately, the cause was probably a combination of poor risk management and macroeconomic issues."

On the other hand, a surprised pause in hikes could lift the digital currency markets and help fuel more appetite for risky assets in general. Another factor that could play in favour of cryptocurrencies and Bitcoin in particular is the banking sector's development.

While regulators continue to monitor the situation, investors could move toward Bitcoin if the crisis shows signs of a resurgence in other banks. Smaller banks could remain exposed in particular if the Federal Reserve decides to raise rates further, adding to the pressure on bond holdings.

Overall, Bitcoin has been gaining market shares to the detriment of other digital assets and could emerge as the clear winner from current developments. Furthermore, Bitcoin has recently seen more resilience than stablecoins, after managing to attract more inflows.