Higher Interest Rates May Be Coming. Here’s Why That’s Bearish for Crypto.
The May readout of the Consumer Price Index (CPI) landed hot at 4.2% on June 10, marking a three-year high. Now, Federal Reserve policy talk has flipped from the possibility of rate cuts to the increasing probability of rate hikes in the near term, and there may be more energy price inflation on the way thanks to the ongoing conflict with Iran. At the same time, the Crypto Fear and Greed Index, a barometer of crypto market sentiment, reads 21, a level denoting extreme fear, and Bitcoin (CRYPTO: BTC), the sector leader, is down 20% in the last 30 days alone.
This is not at all what a good macro backdrop for crypto looks like. Here’s why.
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Why higher rates squeeze crypto
When the Federal Reserve hikes interest rates to tamp down rising prices, it increases the yield on Treasury bonds, which are among the safest investments around.
Higher Treasury yields raise the opportunity cost of holding non-yielding assets, thereby incentivizing capital to pull back from the riskiest sectors of the market, such as crypto. The May CPI print put that hike risk firmly back on the table. Markets are now pricing in a December hike at nearly 51%, up from practically zero just a few months ago.
The Federal Open Market Committee (FOMC) meets June 16 and 17. If history is any guide, the crypto market will sell off in the days leading up to the Fed meeting, and then, if rates actually increase, it’ll be a touch harder for prices to rise for at least a few months thereafter.
But if you hold crypto, don’t be overly concerned about this dynamic. In the long run, quality assets will still be able to grow, as their fundamental value exists outside of whatever price the market assigns to them in any given quarter and, eventually, real value gets recognized by the market.
How leading coins might absorb the squeeze
The headwinds from any rate hikes will affect different coins differently.
Ethereum (CRYPTO: ETH) has significant downside exposure. Its decentralized finance (DeFi) ecosystem competes directly with Treasury yields, potentially leading to capital outflows. Ditto for Solana, which tends to bleed when cheap money dries up.
XRP (CRYPTO: XRP) is a wildcard. It has held up better during the current drawdown, and spot XRP exchange-traded funds (ETFs) keep pulling in new capital even while Bitcoin ETFs are seeing outflows.
