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Why should we care about the Fed raising rates

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The news of interest rate increase sometimes falls and sometimes rises. Who is deciding the pace of interest rate increase? How do they feel about raising rates?

Original title: "In Crypto but confused by Fed rate Hike?"

原文作者：Mabrary

Original source: Oko Cloud chain

This paper will start from the impact of interest rate hikes and quantitative easing on the price of Bitcoin, combined with the attitude of current monetary policy makers towards interest rate hikes, hoping to bring help and inspiration to the interpretation of monetary policy.

First, take history as a mirror: Interest rate hike = bad?

Bitcoin is the originator of Crypto and also a barometer of the market. We compare the market value of Bitcoin, Crypto's internal index of half cycle with external indicators such as federal Reserve rate and QE cycle, and find the change rule between bitcoin price and these four groups of data from historical data.

Fed real interest rate (orange) vs BTC price (log, blue) vs Bitcoin halving cycle (red) vs Fed QE/shrink

Photo credit: OKLink

Note: The green dotted line represents quantitative easing (QE) and the red represents balance sheet Reduction (QT). The horizontal dotted line represents the monthly bond purchase/balance sheet reduction scale, while the shaded area represents the total bond purchase/balance sheet reduction scale during the period.

BTC halving time: 2012.11.28 | 2016.7.9 | 2020.5.12 | 2024.5(estimated)

With the three halving of bitcoin, the price of bitcoin has risen 580 times, 128 times and 18 times in the three bull and bear cycles.

Bitcoin halved its first block reward at the end of 2012, hitting a 12-month phase high of $1160 in November of that year after a slight correction in April 2013. With the low interest rate and the third QE (quantitative easing, 2012.9-2014.10) of the Federal Reserve, the price of BTC increased by 580 times from the low point of $2. At this time, the market value of Bitcoin was small ($13.9B), and the transactions mainly occurred in China. So the Fed's monetary policy actually doesn't have much of an impact on bitcoin's price.

Bitcoin halved for the second time in July 2016, after two bottom confirmations of the BTC price: 2015.1($152)H and 2015.8($198). Since then, the price rose all the way up and reached the stage peak of 19,600 18 months after halving (12, 2017), which was 128 times higher than the stage low. During this period, BTC bucked the trend and reached a market value of $320.2b, 22 times higher than the previous high, despite the fed's no QE action and the substantial rise in real interest rates. It is worth noting that although interest rate hikes failed to curb the growth of bitcoin, the cooling effect of the shrinking of the balance sheet in October 2017 on the bull market was obvious.

Data source: Federal Reserve website

It halved for the third time in May 2020, and opened the upward channel after confirming the bottom at $3850 in March of the same year. Meanwhile, in response to the Coronavirus impact, the Federal Reserve started its fifth round of super-QE in March, two months before the Fed's interest rate fell to a near ten-year low. Due to domestic policy constraints and the growing popularity of BTC in THE US, one of the hallmarks of this bull market has been the 'AMERICANisation', where BTC prices show a strong correlation with US stocks, particularly technology stocks. Sufficient liquidity brought by the favorable monetary policy, coupled with Crypto being more and more recognized by traditional markets, this bull market reached the current price peak of $69,000 in November (19 months after halve), nearly 18 times higher than the bottom of the last bear market, and 2.94 times higher than the previous peak.

Bitcoin's proximity to the United States has also brought the Federal Reserve's monetary policy under scrutiny in the crypto community.

2. Who decides the hawks and doves?

The so-called "doves" and "hawks" originated from the media's depiction of political and diplomatic attitudes, especially war tendencies. Hawks prefer to use tough means to solve problems and cut the tangle quickly. Doves and doves sometimes boil frogs in warm water. In monetary policy, hawks are more sensitive to inflation and hope to control inflation and stabilize prices by tightening monetary policy (such as raising interest rates and shrinking the balance sheet). The doves will place more emphasis on stimulating employment and sustaining economic growth, and will be late to the rate hike cycle.

Monetary policy

The monetary policy of the United States is made by the Federal Reserve. The so-called Federal Reserve rate hikes and cuts are the adjustment of the Federal funds rate by either unchanged or at least 25 points. For example, when the Federal Funds rate is raised by 25 points from 2.25%-2.50%, it becomes 2.5%-2.75%. The decision is announced through the Federal Open Market Committee (FOMC) meeting.

The federal reserve & amp; U.S. Government Cooperation framework

Because of the voting system, decisions to raise or cut interest rates are not made by the fed chairman alone, but by a committee of 12 fed members. Now, let's look briefly at the composition of the Federal Reserve. The Fed has three key entities -- the Board of Governors, the Regional Federal Reserve Banks, and the Federal Open Market Committee. (FOMC).

The competent

The Board of Governors of the Federal Reserve in Washington, D.C. is the governing body of the Federal Reserve system. Board members are nominated by the President of the United States and confirmed by the Senate. Full of seven, only four have been in office so far (222.2) : Fed Chairman Jerome H. Powell, Associate Vice Chair Lael Brainard, Trustee Michelle W. Bowman, and Trustee Christopher J. Waller. The remaining three were nominated by President Joe Biden in January, Sarah Bloom Raskin(left), a former deputy Treasury secretary, to oversee the board, and Philip Jefferson(center) and Lisa Cook(right), two former economists.

Federal Reserve Board member

Then, since the president nominates the 7/12 committee, we have to look at the president's and his party's historical attitude to interest rates. Although the regional fed is not directly appointed by the president, the president can still influence the choice of regional fed chairman indirectly through the governors he nominates. Looking back, the Fed has been more hawkish under Democratic presidents, and it will be interesting to see if Biden will reshape the Fed to be more hawkish.

Federal funds rate vs President's party & NBSP;

Decision-making body

The Fed's main monetary policy tool is Open Market Operations, or buying and selling Treasury bonds and MBS. The Federal Open Market Committee (FOMC) is the policymaking body for monetary policy, and its 12 members vote on which monetary policy tools to use and how to use them. All seven of the aforementioned board members serve on the FOMC, plus New York Fed President John C. Williams, who is a permanent member of the committee. The remaining four members rotate among the 11 regional Fed presidents. Starting in January 2021, the presidents of the Boston, Cleveland, Kansas and St. Louis Fed will serve.

We have summarized the monetary policy preferences of regional Fed governors based on their public statements. As you can see, the hawks are dominant.

It should be noted that since the interest rate hike has become a foregone conclusion, how much to add and when to add should be the focus of the next market.

3. Perspective of expectations

In the first two halving events, the halving cycle and monetary policy alternately affected prices, although the two monetary policies of interest rate hikes and quantitative easing were not decisive on the whole. But with the mainstreaming of BTC, the performance of this risky asset is gradually correlated with the attitude of the Federal Reserve, affecting market expectations in the short term. In recent bitcoin moves, we can see a short-term pattern of BTC prices rallying slightly when hawkish fed comments are in line with expectations; Once expectations are exceeded, prices will fluctuate.

In addition to such short-term sentiment, it is also worth paying attention to when the current rate hike cycle starts to shrink the balance sheet. Looking back at the whole process from the Fed's signal of shrinking its balance sheet from April to October in 2017, the impact of shrinking its balance sheet on asset prices was relatively limited due to the full consideration of expectations, but was more dominated by growth factors. After the start of balance sheet reduction in October 2017, THE US Treasury interest rate rose in the first three quarters of 2018, and the US stock market also rose. In addition to full expectations, earnings fundamentals continued to rise on the back of The Trump tax reform passed at the end of 2017, resisting monetary tightening and higher interest rates.

In this interest rate hike cycle, as the federal Funds target rate is still the main monetary policy tool of the Federal Reserve, the market generally focuses on the pace of interest rate hikes, which may cause insufficient digestion of the expected balance sheet contraction. Minutes from the Fed's January FOMC meeting showed policymakers at the meeting expected to start raising interest rates soon, leaving open the likely timing and size of the fed's drawdown. However, most participants thought that if inflation did not fall as expected, it would be appropriate to tighten monetary policy more quickly, possibly in May. Relative to the digestion time of 17 years and 6 months and favorable policies, this round of shrinking of the balance sheet may have a certain impact on the market if it really starts in May as expected by the market.

Despite the larger "eagle face" of the Fed board, I suspect that the Fed will not raise rates suddenly after Tapper ends in March in order to retain more policy flexibility. The moderate interest rate hike will wait for the response of inflation and employment. If the advance rate increases, the pace of interest rate increase can be increased or even the contraction of the balance sheet; if the decline rate decreases, the interest rate increase can be kept at a small pace, and a better monetary policy plan can be balanced between economic growth, stability and inflation control. However, in the event of more hawkish comments or moves than expected, holding risky assets such as Crypto requires risk prevention and hedging.