The Bullish Fed Rate-Cut Play in Bitcoin Is Not as Straightforward as You Think

• Thursday's inflation report probably set the stage for the Fed to begin cutting interest rates this year.
• While the crypto community expects the first rate cut to kickstart a bull run for bitcoin, the reaction depends on the context in which the bank eases.

The Federal Reserve (Fed) seems increasingly likely to start cutting interest rates this year after yesterday's inflation report, fulfilling crypto bulls' long-standing desire for a more risk-amenable macroeconomic environment.

The consensus in the crypto market community is that rate cuts, likely to begin in September, will boost fiat liquidity, catalyzing demand for riskier investments like bitcoin (BTC).

While that's plausible, markets may have already priced in any easing. Rate-cut expectations have dominated crypto and traditional market sentiment since the second half of 2022 and are among the key catalysts behind bitcoin's surge from 2022 lows near $15,000 to record highs above $73,000 this year. Consequently, the actual rate cut might elicit only a tepid response from the market.

What's likely to be more important is the context in which any interest-rate reduction takes place.

A stimulative effect on asset prices is likely to be more pronounced if a cut comes at a time of low inflation and a thriving economy. One that occurs amid signs of economic fragility might convey a negative signal, prompting investors to rotate money out of riskier assets and into safer ones such as government bonds.

"If the Fed cuts rates solely due to inflation concerns in September 2024, it could be short-term bullish for bitcoin," Markus Thielen, founder of 10x Research, said in a note shared with CoinDesk. "However, if growth concerns drive the cut, either in September or later, bitcoin might face significant selling pressure."

Historically, bitcoin has gained the most when the Fed pauses its cycle of rate increases, Thielen said. The arrival of the first cut has typically met with a tepid response.

"During the Fed's pause from rate hikes until July 2019, bitcoin experienced explosive growth, returning +169%. Following a seven-month pause in 2019, the Fed cut interest rates, initiating a steep rate-cutting cycle. Initially, bitcoin responded positively, rallying +19% within a week after the July 31, 2019, rate cut. However, two weeks later, Bitcoin was back to flat," Thielen said.

Thielen added that the rate cuts in the second half of 2019 were due to economic uncertainties and weighed over BTC's price. The cryptocurrency's price fell 33% in the second half of the year, CoinDesk data show.

U.S. stocks show a similar pattern.

"The arrival of a Fed rate cut cycle has tended to coincide with a sizable stock-market drawdown,” Austin Pickle, a strategist at Wells Fargo Investment Institute, said last month, according to MarketWatch. “Since 1974, the average drawdown has been roughly 20% over 250 days following the first Fed rate cut.”

Pickle added that the stock market would suffer if the Fed is forced to cut rates in response to macro weakness.

That means crypto traders should be watchful of signs of weakness in the U.S. economy.

According to Fidelity's business cycle tracker, the U.S. economy was in the late stage of expansion at the end of the second quarter. Leading indicators like new orders for consumer goods and materials, consumer sentiment and building permits signaled weakness ahead. Should the weakness become more pronounced in coming months, a rate cut will do little for risk assets, including BTC.