How and why does inflation impact the crypto market? The US Consumer Price Index released yesterday surprised on the upside, sending shockwaves through global markets, and cryptocurrencies including Bitcoin and Ethereum were not spared.
BTC and ETH, the two largest cryptos in the market by capitalization, are indeed down 9% and 6% respectively over 24 hours at the time of writing, the day after publication.
Bitcoin points below $20,000, and Ethereum approaches $1,500.
Most of Bitcoin and Ethereum's decline yesterday was recorded within minutes of the US CPI release, but the drop continued late into the night to a low of $19,950. for BTC/USD and $1555 for ETH/USD.
Recall that the general US consumer price index came out at 8.3% in annual data, while the consensus was forecasting a slowdown to 8.1%. The annual Core CPI reached 6.3%, against the 6.1% expected.
But what is the relationship between US inflation and cryptocurrencies? And above all, why did the above-expected US CPI cause Bitcoin and Ethereum to fall so much? This is what we will explain in this article.
First of all, let's briefly recall what inflation and the CPI are.
What is the Consumer Price Index (CPI)?
Each month, the Consumer Price Index measures the cost of a variety of everyday goods and services, from groceries and entertainment to cars and household appliances. Economists use this statistic as a measure of inflation, which refers to the rise in the price of goods and services over time.
The war in Ukraine and its consequences, which have caused the price of many raw materials to explode, have led to an explosion of inflation in the USA and around the world in recent months, so much so that the CPI is currently at a 40-year high in the United States, and the figures released yesterday dashed hopes that the situation would improve quickly.
However, if controlled inflation is beneficial for the economy, prices that soar in an uncontrolled way at present constitute a factor that could lead the US and world economy to recession.
It should be noted that in most countries, central banks are responsible for managing inflation, in particular via interest rate policy. And it is precisely the impact that the US CPI could have on the next decisions of the American Fed which explains the strong bearish reaction of cryptocurrencies and risky assets in general yesterday.
What is the relationship between high inflation and the fall of cryptocurrencies?
The higher-than-expected US inflation figures published yesterday, therefore, reinforce the likelihood that the Fed will continue to tighten its monetary policy massively, or even accelerate the rate hike even further.
And you're probably wondering why the Fed's rate hike is causing cryptocurrencies to fall, whether it's Bitcoin, Ethereum, or most other digital assets in the market.
The explanation is simple: The rise in US rates increases the return on risk-free investments, such as term accounts or passbooks or their equivalents. With attractive remuneration, investors are less willing to take risks in cryptocurrencies and other markets to obtain a higher return.
In addition, rising rates increase the cost of money. In other words, it becomes more expensive to borrow, and therefore less profitable for investors to borrow to invest.
Finally, the sharp rise in rates by the Fed and other central banks is also having the effect of significantly slowing the economy and risks pushing it into recession, creating uncertainty about the future which is prompting investors to take minimal risk. In the world of finance, this means, among other things, staying away from cryptocurrencies.
Why the US CPI released yesterday had such an impact on cryptos?
More concretely, the US CPI published yesterday, therefore, led investors to revise their forecasts for the Fed meeting next week upwards. Indeed, the market is now taking into account a 35% probability of seeing the Fed raise its rates by 1%, against 0.75% during the 3 previous meetings, whereas this possibility was not considered the day before.
Indeed, if the 3 rate hikes of 0.75% that the Fed has carried out in recent months have not succeeded in containing inflation, there is a good chance that it will draw the conclusion that it must act even more decisively.
But a 1% rate hike is still a long way from the market's baseline scenario, so cryptocurrencies could potentially rebound or fall further depending on how expectations change between now and the FOMC meeting next week.
Cryptocurrency traders will therefore have to closely monitor the interventions of the various members of the Fed, the comments of analysts as well as any press information on this subject over the next few days.
0 Comments