Cryptocurrency Markets Poised for Rally as Federal Reserve Nears End of Interest Rate Hikes

The cryptocurrency industry could soon breathe a sigh of relief, as the Federal Reserve is expected to signal an end to its series of aggressive interest rate hikes that have weighed heavily on digital asset prices over the past year.

According to a report published Tuesday by Grayscale Investments, one of the world's largest cryptocurrency asset managers, the Fed's policy-setting committee will likely communicate after its meeting Wednesday that it has either finished raising rates or will do so after one additional increase. This shift in posture reflects growing evidence that the central bank's rate hikes have begun slowing rampant inflation that has plagued the economy.

With interest rates now at their highest level since before the 2008 financial crisis, analysts say the Fed seems to be entering the final stages of its effort to cool the overheated economy and temper speculation in financial markets. This could pave the way for a recovery in asset prices across the board, including those of cryptocurrencies which have moved in lockstep with the Fed's policy maneuvers.

The price of Bitcoin, the bellwether cryptocurrency, surged in late 2020 when the Fed's stimulus pushed real interest rates into negative territory. However, it sank dramatically through 2022 as the central bank embarked on an aggressive rate-hike regimen to combat surging inflation.

"We may now be approaching the next stage in this process," wrote analysts at Grayscale in their report. They contend that regardless of whether the Fed announces another rate increase on Wednesday or pauses its tightening campaign, the broad shift in policy appears to be concluding.

This could provide a boost to the cryptocurrency markets, which have languished amid broad risk-off sentiment driven largely by the Fed's actions. Here's what investors and industry players need to know about the current landscape:

The Fed's Pivotal Role in Cryptocurrency Price Action

The Federal Reserve's monetary policy maneuvers have been a key driver of cryptocurrency price action over the past couple years. This is because digital assets like Bitcoin are widely considered risk-on investments, while interest rates affect their relative attractiveness.

When interest rates are low and monetary policy is accommodative, investors tend to allocate more capital into higher-risk, higher-potential-reward investments like cryptocurrency. But when rates rise, safer assets like bonds become more appealing. This dynamic played out over the past two years.

The Fed slashed rates to zero in early 2020 after the onset of the pandemic, while also launching massive quantitative easing asset purchase programs. This influx of liquidity into the financial system, coupled with low returns in bonds, drove investors into Bitcoin as a hedge against inflation. Bitcoin went on a parabolic bull run through 2021 until the Fed began signaling it would tighten policy.

As the central bank followed through with an aggressive series of rate hikes starting in March 2022, Bitcoin plunged from its all-time high near $69,000 to under $17,000 by year-end. The overall cryptocurrency market capitalization shrank by over $2 trillion.

Now, as the Fed appears poised to slow its tightening pace, Bitcoin and altcoins seem ready for a relief rally.

Cryptocurrency Adoption Remains Strong Despite Price Volatility

While cryptocurrency prices have gyrated wildly alongside Fed policy shifts, adoption of digital assets continued apace over the past couple years.

There are now over 220 million Bitcoin wallets opened globally, up 66% from 2021, according to data from Statista. Coinbase, the largest U.S. cryptocurrency exchange, grew its quarterly trading volume from $145 billion in Q4 2021 to over $217 billion in Q3 2022.

payment processors like Visa, PayPal and Block have integrated various cryptocurrency capabilities. Major institutions like BlackRock, JPMorgan Chase and Fidelity Investments have launched asset management services. Tesla even briefly accepted Bitcoin as payment for its electric vehicles.

Clearly, real-world cryptocurrency adoption has persisted and expanded despite the down market. While speculators fled once the Fed tightened liquidity conditions, long-term crypto believers continued accumulating digital assets.

This growing practical usage of cryptocurrencies to transfer value, make payments and serve other functions will ultimately decouple their prices from monetary policy shifts. But in the near-term, the conclusion of the Fed's tightening campaign appears a prerequisite for the next major crypto bull market.

What Comes Next for Bitcoin and the Crypto Market

Cryptocurrency investors endured a painful year in 2022, but the news likely to emerge from the Fed this week could mark an inflection point.

While higher interest rates make holding guaranteed yield-producing assets like bonds and cash more attractive on a relative basis, riskier investments become more compelling when the rate hike cycle concludes. With the Fed apparently nearing the end of its tightening campaign, the next rotation into risk-on positions could drive major rallies in beaten-down sectors.

Cryptocurrencies like Bitcoin and Ethereum would be prime candidates for upside price action in such an environment. And with crypto adoption still expanding despite market conditions, any Fed-driven relief rally could have more lasting momentum.

Of course, the central bank's policy outlook remains data-dependent. If inflation proves stickier than expected, additional rate hikes could be forthcoming, dashing hopes of a renewed crypto bull market. But for now, the Fed appears on track to loosen financial conditions.

For cryptocurrency investors, a light finally seems visible at the end of the long bear market tunnel.

The Philosophical Import of Bitcoin's Relationship with the Fed

While in the practical near-term sense, Bitcoin and cryptocurrencies appear poised to benefit from a less hawkish Federal Reserve, there is a deeper philosophical tension between decentralized digital assets and central banking policy.

Satoshi Nakamoto's vision for Bitcoin was a currency with a fixed supply, immune from debasement and inflationary manipulation. This represents the antithesis of the Fed's discretionary monetary policy aimed at managing growth and prices. In this way, Bitcoin was designed as a countermeasure to central bank overreach.

Yet the Fed's actions still impact Bitcoin's value, as became evident over the past couple years. This represents an ideological conflict at the heart of cryptocurrencies. Although conceived to circumvent centralized control, they remain tied to the machinations of central bankers who pull the levers of the global financial system.

Some crypto purists argue that Bitcoin cannot truly fulfill its purpose until it attains sufficient adoption to become "uncorrelated" from broader monetary policy shifts. Others see the correlation with the Fed's tightening as evidence that cryptocurrencies are not yet a mature asset class or viable money alternative.

As adoption expands, Bitcoin's connection with the Fed's actions may ultimately weaken. But for now, its price remains tied to the central bank's maneuvers. The philosophical impediment this poses for cryptocurrencies will only resolve once they are being used widely enough to be impacted more by their own supply and demand rather than central bank policy. The conclusion of the Fed's tightening cycle could be a stepping stone toward that independence.

Conclusion

The Federal Reserve's upcoming policy decision could have major implications for cryptocurrency markets if it signals an end to interest rate hikes. While higher rates have weighed on prices over the past year, evidence suggests the Fed may be nearing the conclusion of its tightening campaign as inflation shows early signs of abating.

This could pave the way for a rotation back into risk assets that would benefit Bitcoin and the broader crypto market. However, the philosophical tension between decentralized cryptocurrencies and centralized monetary policy will persist until adoption reaches levels that decouple digital assets from central bank maneuvers. Still, the Fed's expected policy shift could provide crypto investors much-needed relief after a brutal 2022 bear market.

How high can Bitcoin realistically rise during this potential relief rally?

If the Fed does signal it is nearing the end of its rate hiking cycle, Bitcoin could stage a significant relief rally from current levels below $20,000. However, there are several technical and fundamental factors that may limit just how high Bitcoin can bounce in the near-term:

• Resistance levels - Technical analysts will be watching to see if Bitcoin can break back above key resistance around $25,000. This area near its 2021 bull market peak may cap initial upside. Subsequent resistance sits around $40,000 and $50,000.
• Macroeconomic uncertainty - Even if the Fed pauses hikes, high inflation and slowing growth could still weigh on risk sentiment limiting Bitcoin's upside. The crypto rally may require evidence of a "soft landing."
• Lingering effects of liquidity tightening - Asset prices across the board could remain depressed for a period even after rate hikes stop as liquidity is slowly reintroduced to markets. This may mute the intensity of Bitcoin's rally.
• Loss of momentum from previous bull run - Following its parabolic rally in 2020-21, Bitcoin may see more gradual gains as investors remain cautious after the severity of the bear market.

Without the excessive bullish euphoria seen in 2021, Bitcoin realistically could return to the $40,000 to $50,000 range where it consolidates before attempting to reach new highs. Sudden surges back above $60,000 seem unlikely in the near-term. Ultimately, fundamental adoption and use cases will need to drive valuations higher once again.

What factors could upend a potential cryptocurrency market rally?

While hopes are high that an end to Fed rate hikes could reinvigorate digital asset prices, there are several risks that could derail an anticipated cryptocurrency rally:

• Renewed inflation spike - If inflation re-accelerates against expectations, the Fed may be forced to resume rate hikes, tightening liquidity conditions. This would likely extend the crypto bear market.
• Geopolitical turmoil - Major escalations in conflicts such as the war in Ukraine could spark another risk-off episode, sending cryptocurrencies lower regardless of Fed policy.
• Regulatory clampdowns - Increased scrutiny from government agencies could spook investors, undermining any Fed-driven relief rally, especially if dramatic new rules are proposed.
• Technical breakdown - If major support levels like $17,000 fail to hold, technical selling could worsen dragging Bitcoin lower even if the Fed pauses tightening.
• Contagion from crypto sector turmoil - Ongoing liquidity issues in crypto lending and exchanges could create cascading losses that quash positive sentiment even if the macro outlook improves.

While likely exhausted from its aggressive rate-hike regimen, the Fed doesn't have full control over inflation or geopolitics. Until clear evidence emerges of broader economic stabilization, cryptocurrency markets remain vulnerable to these external shocks derailing any incipient price bounce.