The impact of U.S. monetary policy shift on cryptocurrency

The core factor that determines the market is capital. The bull market stems from the continuous inflow of incremental funds and the continuous growth of stock funds; the bear market is the sluggishness of incremental funds and the continuous flight of stock funds.

Simply put, loose monetary policy, on the one hand, is the continuous increase in the amount of funds in the entire society; on the other hand, it has brought about the depreciation of legal currency. Investors have increased their funds, and for the purpose of protecting assets in their hands, they have sought to maintain or increase their value beyond the inflation rate, and continue to spread their funds to major financial markets. Regardless of whether Bitcoin is used as a wealth creation myth or as a powerful means to combat hard inflation, it has attracted the participation of a large number of retail investors and institutions, allowing this immature market to move forward with the continuous influx of incremental funds and the continuous fullness of stock funds. To a new climax.

The impact of U.S. monetary policy shift on cryptocurrency

2020.1-2021.5 U.S. M1 and M2 currency stocks (Billions of Dollars) (Data source: FRED official website)

However, the carnival dissipated, and the 28th law still took effect. The price of Bitcoin plummeted at its peak, and most of the money made by investors in the bull market was eventually repaid, and even the principal was lost. The myth of institutional admissions is also shattered, and even more listed companies buy at high points and are laughed at as “big leeks.” The market trading volume continues to be sluggish, and the gap between longs and shorts has significantly increased. In this uncertain situation, we may wish to revisit the fundamentals that have driven the cryptocurrency market to rise.

This article refocuses on the loose monetary policy of the United States, and explores the impact on the cryptocurrency market through the background, transmission path, and changes of monetary policy implementation. Through analysis, the author believes that the fundamentals of monetary policy before and after the crypto market are quietly undergoing subtle changes . In the future, the United States will inevitably embark on the path of raising interest rates, which leads to the potential impact that future tightening monetary policies may have on the cryptocurrency market.

U.S. quantitative easing monetary policy implementation background

Economic development is undermined by the epidemic

On the eve of the outbreak, the quarterly growth rate of US GDP (gross domestic product) remained at about 2%. When the epidemic broke out in 2020, the US GDP fell sharply, reaching an astonishing -9.033% growth in the second quarter. Under the impact of the epidemic, the consumption level and domestic capital investment of the two major driving forces of US economic growth have been severely suppressed. Then around March 2020, the Federal Reserve began to implement a substantial quantitative easing policy, by signing a rescue plan to rescue the market, frantically “spending money” into the market in order to promote consumption and investment. The U.S. economy has improved, and the gross domestic product has begun to change from negative growth to positive growth.

The impact of U.S. monetary policy shift on cryptocurrency

2018.1-2021.3 U.S. Real GDP: Year-on-year: After quarterly adjustments 

Severe unemployment

At the beginning of the epidemic, the US unemployment rate remained below 4%. From January 1948 to March 2021, the average US unemployment rate was 5.6%. After the epidemic broke out in full, in April 2020, the US unemployment rate soared to 14.8%, which is the highest value in history since observational data. The subsequent months have gradually declined, but as of March 2021, the unemployment rate is still higher than the historical average. The unemployment rate remains high, making the impact of this epidemic crisis on the domestic economy of the United States greater than in the past.

The impact of U.S. monetary policy shift on cryptocurrency

2019.12-2021.3 U.S. unemployment rate (data source: CEIC official website)

Maintain the federal funds rate at 0-0.25% for a long time

As the U.S. government failed to effectively control the epidemic, the U.S. economy and financial markets were dragged down by the epidemic into recession. In March 2020, the U.S. extended the federal funds rate to the lower limit of zero and maintained the federal funds rate at 0-0.25% for a long time. Low range interval level. The effective space of the traditional monetary policy that uses interest rates as the intermediary target tool has basically been lost.

The impact of U.S. monetary policy shift on cryptocurrency

2017.6-2021.6 United States effective federal funds rate (Percent) (data source: FRED official website)

In summary, the background of the United States’ monetary policy for implementing quantitative easing can be summarized as follows:

The epidemic cannot be controlled for a long time, domestic consumption and investment are sluggish, and the U.S. economy is going backwards;

The unemployment rate has soared, the public panic, and expectations are damaged;

The traditional moderate monetary policy has failed.

Based on this situation, in order to reverse the downward trend, the United States implemented an open-ended quantitative easing monetary policy, and used medium- and long-term bonds such as treasury bonds with no quota to maintain the smooth operation of the market and ensure the effective transmission of monetary policy. It can also be simply understood as the indirect printing of banknotes, injecting a large amount of liquidity into the market, so it is called “unlimited QE” by investors.

The cryptocurrency market, led by Bitcoin, is more prosperous under this macro background, and is reaching a new peak step by step.

U.S. loose monetary policy affects the transmission mechanism of cryptocurrency

Exchange rate transmission

Since March 2020, the United States has implemented an open-ended quantitative easing monetary policy and injected a large amount of liquidity into the market. As the world currency, the U.S. dollar has inevitably increased when the supply of U.S. dollars has increased substantially and demand for U.S. dollars has hardly changed. Devaluation occurred.

The impact of U.S. monetary policy shift on cryptocurrency

2019.11-2021.6 USD Index DXY (Data source: Trading View)

As the number one opponent of the U.S. economy, China, with the effective control of the domestic epidemic in China, the effective resumption of work and production, the rapid recovery of China’s economy, and the appreciation of the renminbi against the dollar, the exchange rate of the renminbi and the dollar is facing great pressure to appreciate. . If you think of Bitcoin as a currency, it can be compared to the renminbi mentioned above. Bitcoin and legal currency are negatively correlated. Under the general environment of legal currency depreciation, the exchange rate of Bitcoin to USD will maintain an upward trend. Therefore, in the wave of economic globalization, the profit-seeking effect of capital will inevitably cause the outflow of US dollars, and a considerable part of the “hot money” will flow to countries or markets with better investment returns. In addition, the nominal wealth of American residents has increased due to the quantitative easing monetary policy, and a considerable part of the funds will flow into the cryptocurrency market (mainly Bitcoin), which will affect the price of Bitcoin.

In general, the exchange rate transmission mechanism of the US quantitative easing monetary policy to the cryptocurrency market can be as follows:

The United States implements a quantitative easing monetary policy, the base currency of the U.S. dollar increases, the U.S. dollar money supply increases, and the book wealth (nominal wealth) of residents increases;

The liquidity of the U.S. dollar increases, and the fluctuation of the U.S. dollar exchange rate shows a depreciation trend;

“Hot money” flows into the cryptocurrency market led by Bitcoin with a good return on investment;

With the influx of incremental funds, the stock of funds has grown, the price of Bitcoin has risen, and the exchange rate against the U.S. dollar has shown an upward trend.

The impact of U.S. monetary policy shift on cryptocurrency

The quantitative easing monetary policy of the United States affects the exchange rate transmission path of the cryptocurrency market (picture source: Wu Shuo Blockchain production)

International capital flow

In response to the impact of the epidemic on the domestic economy, developed countries such as the United States, Japan, and Western Europe have adopted quantitative easing policies to inject a large amount of liquidity into the global economy and form a large amount of short-term international circulating capital. These short-term international circulating capital pursue high-return financial products to obtain substantial investment returns, and have obvious characteristics of speculation and arbitrage.

Bitcoin has experienced more than ten years of development. In addition, the cryptocurrency market will become more active due to the DeFi boom in 2020 and still maintain a high return on investment. Therefore, the cryptocurrency market led by Bitcoin has become an investment in major advanced economies. In the period of quantitative easing monetary policy, one of the main markets for international capital to pursue speculative gains.

Expected currency tightening

Observability of U.S. Monetary Policy Turn

The U.S. economy is gradually recovering

Although the US GDP was hit hard in 2020, the US economy is gradually recovering after several rounds of quantitative easing monetary policy. As can be seen from Figure 1, the US GDP growth rate is gradually picking up. As of the first quarter of 2021, US GDP has returned to positive growth. Both the consumption level and capital investment of the two major driving forces of US economic growth have returned to a relatively high level.

The impact of U.S. monetary policy shift on cryptocurrency

2019.12-2021.3 U.S. private consumption expenditure (100 million U.S. dollars) and 2019.12-2020.12 U.S. foreign investment portfolio (million U.S. dollars) (data source: CEIC official website)

Unemployment rate is expected to improve

CEIC’s official website predicts that the unemployment rate in the United States is expected to return to below the historical average in 2022. The gradual decrease in the unemployment rate of residents is an important support for economic recovery.

The impact of U.S. monetary policy shift on cryptocurrency

2019.12-2026.12 US unemployment rate forecast (data source: CEIC official website)

Inflation expectations are solid, and interest rate hikes are inevitable

The Consumer Price Index (CPI) is an index that measures the changes in the overall level of prices on the market. Generally, market economy countries believe that the CPI is within an acceptable range of 2%-3%. Since the United States implemented the quantitative easing monetary policy in March 2020, its impact has produced negative feedback in 2021. In 2021, the CPI is rising steadily. In May 2021, the CPI in the United States increased by 4.9% year-on-year.

The impact of U.S. monetary policy shift on cryptocurrency

2019.12-2021.5 U.S. consumer price index CPI growth (data source: CEIC official website)

In May 2021, the U.S. Producer Price Index (PPI) increased by 6.5% year-on-year, compared with a year-on-year increase of 6.1% last month. The accelerated rise of the US producer price index undoubtedly further aggravated inflationary pressures.

The impact of U.S. monetary policy shift on cryptocurrency

Figure 10 The increase in PPI of the U.S. producer price index from December 2019 to 2021.5 (data source: CEIC official website)

In addition, there are also indicators such as ten-year U.S. Treasury bonds and the commodity price index that point to the high currency currently facing the United States. The adjustment of the federal funds rate is inevitable, and the increase in interest rates is inevitable, and the monetary policy will also turn to tightening.

In Fred’s forecast, the Federal Open Market Committee (FOMC) is expected to raise the federal funds rate from 2022, that is, to raise interest rates, and the median federal funds rate will reach 0.6%.

The impact of U.S. monetary policy shift on cryptocurrency

FOMC federal funds rate median economic forecast summary (Percent) (data source: FRED official website)

U.S. monetary policy shift and tightening will have an impact on the cryptocurrency market

Funds may flee in a large amount in the short term

In the international capital flow just now, it was mentioned that investors from various countries have shifted to the speculative and high-return cryptocurrency market due to avoiding the negative impact of the country’s quantitative easing monetary policy, and injected a large amount of money into the cryptocurrency led by Bitcoin. fluidity. However, with the current economic recovery of various developed economies, the funds originally deposited in the cryptocurrency market may flee in a large amount in the short term, leading to a reversal of market capital flows. The flow, stock and direction of these “hot money” will have a profound impact on the cryptocurrency market, thereby affecting the trend of Bitcoin prices.

The author believes that in the current cryptocurrency market, there have been signs of capital flight.

“Herding effect”, the withdrawal of large funds caused panic

The author believes that the shift in U.S. monetary policy and when to turn to this issue has brought a certain degree of psychological concern to the cryptocurrency market. Once upon a time, investors are now paying close attention to economic meetings in the U.S. that can be large or small and have no short-term impact. This actually reflects concerns about monetary policy, because high inflation has made it clear to investors that interest rate hikes are not possible. avoid. Once the exact announcement of when to raise interest rates or when to make a more explicit tightening will not only affect the flow of “hot money” in short-term capital in the world, it will also affect the capital situation in the market and the psychological expectations of investors. If large institutions or large companies choose to withdraw their large funds, market panic will spread further and further affect the price of Bitcoin.    

The impact of U.S. monetary policy shift on cryptocurrency

U.S. Monetary Policy Shift to Tightening Transmission Path of Capital Flow in the Cryptocurrency Market

The possible long-term deflation will allow the cryptocurrency market to usher in a truly healthy development

One of the obvious drawbacks of the crazy influx of funds is that the market is flooded with excessive “leeks” and “Ponzi schemes.” During the crazy period of Meme tokens, a large amount of funds flowed in, and many investors speculated on various animal tokens with the dream of getting rich overnight. Of course, it is not possible to let the masterpieces exist in it, but it is more of a chicken feather after the craze has passed. The increase in market liquidity has also increased the madness of investors, allowing project parties to find more ways to cut leeks.

Some macroeconomists believe that the United States may achieve monetary tightening in the next decade. If monetary policy shifts to long-term deflation in order to reverse high inflation, then the funds flowing into the market will be reduced, and there will be a situation of exodus and segregation of stock funds. Based on such conditions, project tokens in the cryptocurrency market may be prompted to pay more attention to the value of products and users, and the development of the cryptocurrency market may be more healthy. At the same time, under the condition of healthy development, attract off-market funds to enter the layout.

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