How will the Fed start to shrink its balance sheet as soon as May and affect Bitcoin?

The minutes of the Fed’s meeting hinted that the policy combination of “raising interest rates by 50BP + opening the balance sheet” may come to fruition in May. The interest rate hike and the balance sheet shrinking will be carried out simultaneously, and the U.S. monetary policy will enter the era of “double tightening of volume and price”.

Last night this morning, the minutes of the March monetary policy meeting released by the U.S. Federal Reserve showed that in the face of continued high inflation, Fed officials believe that there may be several 50 basis points of interest rate hikes in the next regular meeting, and may be as early as In May, the balance sheet was reduced by up to $95 billion per month ($60 billion in Treasuries + $35 billion in MBS).

The minutes show that Fed officials discussed the roadmap for reducing the balance sheet at the March 15-16 monetary policy meeting, believing that in the context of raising interest rates to deal with inflation, reducing the balance sheet will play an important role in strengthening the monetary policy stance, And expects it will be appropriate to start the process at an upcoming meeting, possibly as early as May.

Fed officials generally agree that risk management will be important in determining the appropriate stance of monetary policy, and that policy also needs to be flexible in response to new data and the changing outlook. Amid soaring inflation and a tight labor market, Fed officials expect this round of balance sheet reductions to be faster than in 2017-2019, when the Fed’s largest monthly reduction was $50 billion.

Fed officials as a whole agreed to set a monthly cap on gradual reductions of $60 billion in Treasuries and $35 billion in mortgage-backed securities, arguing that a maximum reduction of $95 billion per month was appropriate. Officials also said the cap could be phased in over three months or slightly longer if market conditions demanded it.

In addition to discussions about shrinking balance sheets, officials discussed a roadmap for future rate hikes, and they favored more aggressive moves. The minutes mentioned that many Fed members would likely have called for a 50 basis point rate hike in March, had it not been for the Ukraine conflict.

The minutes noted that many participants noted that at future meetings, a 50-basis-point increase in the target range may be appropriate, especially if inflationary pressures continue to rise or intensify.

Facing the worst inflation situation in the United States in 40 years, the Federal Reserve announced on March 16 that it raised the target range of the federal funds rate by 25 basis points to between 0.25% and 0.5%. This is the Fed’s first rate hike since December 2018, and it also marks the official end of the Fed’s zero interest rate policy since March 2020 in response to the COVID-19 pandemic, and the beginning of a new round of rate hikes.

Next, according to CME’s “Federal Reserve Watch”: the probability of the Fed raising interest rates by 25 basis points by May is 22.9%, the probability of raising interest rates by 50 basis points is 77.1%, and the probability of raising interest rates by 75 basis points is 0%; by June The probability of a 25 basis point hike or a 50 basis point rate hike is 0%, the probability of a 75 basis point rate hike is 14.7%, the probability of a 100 basis point rate hike is 57.8%, and the probability of a 125 basis point rate hike is 27.6%. 

After the minutes were released, Chris Zaccarelli, chief investment analyst at Independent Advisors Alliance, analyzed that the $95 billion monthly reduction target is a “good start”, but the Fed may need to cut spending at a faster pace to fight inflation. At the current rate, it may take more than 5 years (maybe as long as 8 years) to fully realize all securities held. Before this happens, there is a good chance that we will have a recession, which could force the Fed to increase its balance sheet again, so market distortions could persist for a long time. 

In the last cycle of shrinking the balance sheet, there were certain twists and turns in the cryptocurrency market. In the fourth quarter of 2018, at the same time that the scale of the single-month shrinkage reached its peak, Bitcoin experienced a large decline. At the time, Powell commented that interest rates are “a long way to go” from neutral, which triggered more panic, and a sell-off in U.S. stocks, which drove Bitcoin down.zUwXbwEMaFrZFv3oV2Q0TUGh4Z6ZVWWkMpZ4Z83F.png

And this round of interest rate hike and balance sheet reduction is coming, how will it affect the crypto market? Speaking with BTC advocate and investor Anthony “Pomp” Pompliano at the Bitcoin 2022 conference in Miami on Wednesday, Galaxy Digital CEO Novogratz said that Bitcoin’s recent performance left him in the dark considering macro headwinds such as Fed rate hikes deep impression. Novogratz said that I think Bitcoin is trading very well and believes that Fed Chairman Jerome Powell has “realized that he is behind the curve” and warned that he may be “very hawkish” for some time. “. “Powell wants to maintain his reputation. Once the Fed pauses rate hikes, I think bitcoin will skyrocket,” Novogratz noted.

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