Last week, the Federal Reserve announced its first interest rate cut in four years, an event that was widely anticipated but brought mixed reactions across the markets. Despite expectations surrounding this move, the market’s varied responses have sparked a critical question: what are the potential consequences of this decision?

In this article, we will analyze the FED's rate cut, and explore the possible implications for the crypto markets in the aftermath of this pivotal decision.

Recap

In response to the global crisis triggered by the COVID-19 pandemic, governments around the world were forced to substantially increase the money supply to cover the immense costs of vaccine development, healthcare systems, and social support programs. The United States was no exception, and the economic policies implemented during this period resulted in one of the most dramatic expansions of the monetary base in history, as depicted in the graph below:

As a consequence of this unprecedented expansion of the monetary base, the United States experienced one of the highest inflation rates in its history, exceeding 8% in 2022. In an effort to curb these soaring inflation levels, the Federal Reserve was left with no choice but to raise interest rates significantly. Interest rates were raised to their highest levels since 2007, reaching the 5.25% to 5.5% range, and were maintained at this restrictive level for an extended period.

Source: TradingView

During this period, the crypto market struggled under heavy restrictions, with Bitcoin dropping to lows around $16,000 and prices remaining down until the second half of 2023. By year-end, there was broad market anticipation that the Federal Reserve would start cutting interest rates, as the high levels were seen as unsustainable for the U.S. economy and could lead to a severe recession. In response, risk assets rallied globally, with investors betting on a “first cut” in March. Bitcoin surged to an all-time high of $71,000, and many altcoins also saw significant gains during this time.

However, the Federal Reserve remained unconvinced that inflation would consistently reach its 2% target, as various economic indicators suggested that the U.S. economy remained resilient despite the restrictive monetary policy. Consequently, the Fed opted for a cautious approach in its meetings, maintaining high interest rates for a longer period than initially expected.

The decision

Last week, the Federal Open Market Committee (FOMC) announced its first interest rate cut since 2020 during the September press conference, reducing rates by 0.5% to the 4.75% - 5% range. This decision came as a slight surprise, as most forecasts had anticipated a more modest 0.25% cut, with expectations of subsequent reductions of similar magnitude through the end of the year. Following the announcement, crypto markets responded positively, with Bitcoin surging from $58,000 to a peak of $64,000, and Ethereum rising by over 10% to approximately $2,600.

During the press conference, Federal Reserve Chairman Jerome Powell reiterated the Fed's commitment to its dual mandate of price stability and maximum employment. With confidence that inflation will eventually converge toward the 2% target in the long term, the Fed has now "shifted focus" towards sustaining job growth and supporting the broader U.S. economy to avoid a potential recession. Recent non-farm payroll reports have shown signs of a cooling labor market, and it appears the Fed is increasingly concerned with reversing this emerging trend.

While these indicators provide some insight into the FED’s future direction, Powell emphasized that decisions will continue to be made on a "meeting-by-meeting" basis, guided by the latest available data. Consequently, he did not offer any specific guidance on what to expect in the upcoming meetings.

The upcoming Non-farm Payroll and Consumer Price Index (CPI) data will be critical in shaping the FED’s next steps, making close attention to these releases essential. There are multiple scenarios based on the potential paths they might take, and we will explore these outcomes in the sections below.

What 's next?

The larger-than-expected rate cut signals that the FED is committed to taking bold actions if the economy shows signs of weakness. This is particularly positive for cryptocurrencies, as they are highly correlated with other risk assets globally, which tend to benefit most from more accommodative interest rates.

If the economy stays stable and inflation continues to move toward the target, we can expect a series of rate cuts ahead, as current interest rates are still far from what is considered "neutral." In this scenario, a bull run could be on the horizon, with increasing capital flowing into crypto, especially from VC funds.

However, it’s essential to remain vigilant about ongoing geopolitical tensions worldwide. Even with positive economic indicators and prospects of lower rates, the situation could shift quickly if any of these conflicts escalate. Historically, risk assets are the most affected during times of geopolitical tension, and an escalation could rapidly reverse the economic outlook.

Source: CBS

There’s also the possibility that a more lenient monetary policy could overstimulate the labor market, potentially driving inflation back up. Although this scenario is less likely, it could prompt the FED to halt its rate cuts or even consider hiking rates again.

Final notes

Assuming conditions remain steady, the FED appears set to continue cutting rates, albeit in smaller, incremental steps rather than another steep 0.5% cut, until rates return to a neutral stance. However, it’s crucial to be mindful of external factors that could disrupt this likely path, especially when making portfolio decisions.

Please note that all content in this article is for informational purposes only and should not be interpreted as financial advice. Always conduct your own research when making decisions about building your portfolio and trading tokens.

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