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How A Surprise Fed Rate Hike Announcement Could Send Stocks And Crypto Into A Downward Spiral


Despite the hedge-against-inflation hype promoted by some crypto holders, Bitcoin has been correlated with the price action of traditional stocks and some investors worry that a surprise Fed rate hike announcement could send both into a downward spiral.

In response to the hottest inflation in 40 years, Federal Reserve Bank of St. President James Bullard said he supported raising interest rates by a full percentage point by the beginning of July. That statement is credited with helping to knock more than 500 points off the blue-chip Dow Jones Industrial Average on Thursday, and with pushing down the Nasdaq by more than 2 percent. 

The consumer price index, which measures the cost of everyday goods, rose a higher-than-expected 7.5 percent in January compared with a year ago, surprising some investors and sending stocks lower on Feb. 10 after a rally a day earlier. The yield on the benchmark 10-year US Treasury, which moves opposite to prices, soared above 2 percent for the first time since 2019. It was close to 1.5 percent at the end of 2021.

Investors are especially worried, however, about the yield on shorter-term US bonds such as the two-year note, which has risen even more dramatically. It’s now above 1.5 percent, gaining about 110 percent so far in 2022. If yields on shorter-dated bonds jump above the 10-year — producing an inverted yield curve — that’s a sign that investors expect a deterioration in near-term economic conditions and aggressive intervention from the Federal Reserve, CNN reported. In 2018, the Federal Reserve Bank of San Francisco published research that found a yield curve inversion preceded every recession since 1955 with just one “false positive.”

Federal Reserve Chairman Jerome Powell, who repeatedly downplayed the risk of inflation earlier in 2021, finally said in December that he was retiring the word “transitory” to describe the inflationary outlook and believed that the omicron variant could threaten the U.S. economy.

The Fed is so behind the curve that some economists predict it may not wait until its scheduled March Federal Open Market Committee (FOMC) meeting to unleash a rate hike.

A surprise Fed rate hike announcement could be in the cards as soon as Monday, said economist Tim Duy at SGH Macro Advisors. “I know, this is crazy aggressive,” he said in a note. “We have no inside information. It is just getting to the point where the distance between the Fed’s current position and reality is too wide to ignore.”

Former Treasury Secretary Lawrence Summers said that the Federal Reserve should hold a meeting immediately to end quantitative easing — now scheduled to end in March — to show it’s determined to stop inflation.

“The Fed should have a special meeting, right now, to end QE,” Summers told Bloomberg TV. “It is nothing short of preposterous that in an economy with 7.5 percent inflation, that in an economy with the tightest labor market we’ve seen in two generations, that the central bank is still as we speak growing its balance sheet.”

If it does happen, it wouldn’t be the first surprise Fed announcement. Major events in the past triggered a surprise announcement over worries such as inflation or hyperinflation. For example, a global stock market crash began in February 2020 after the world started shutting down in response to the coronavirus pandemic. On March 3, 2020, the Fed made an emergency rate cut of 0.50 percent from 1.75 percent to 1.25 percent to combat the economic risk of covid-19. It was the first emergency rate cut since the 2008 financial crisis and came 15 days before its scheduled meeting. The Fed subsequently cut rates further. The stock market crash ended in April, 2020.

Paul Volcker was chairman of the Federal Reserve from 1979 to 1987. He is best known for an extreme and prolonged interest rate rise called the Volcker Shock. Volcker fought annual inflation rates higher than 10 percent and was considered courageous for raising the Fed funds rate to 20 percent in March 1980. He briefly lowered it in June. When inflation returned, Volcker raised the rate back to 20 percent in December and kept it above 16 percent until May 1981. “It did end inflation. Unfortunately, it also created the 1981 recession,” according to a blog in The Balance.

Listen to GHOGH with Jamarlin Martin | Episode 74: Jamarlin Martin Jamarlin returns for a new season of the GHOGH podcast to discuss Bitcoin, bubbles, and Biden. He talks about the risk factors for Bitcoin as an investment asset including origin risk, speculative market structure, regulatory, and environment. Are broader financial markets in a massive speculative bubble?

Investors have flocked to cryptocurrencies seeking a hedge against inflation and returns that are uncorrelated to traditional asset classes such as stocks, bonds, and precious metals. However, the historical price action of the No. 1 crypto, Bitcoin — often described as an alternative to gold or “digital gold” — suggests it’s more closely related to stocks.

When stocks fell nearly 20 percent in the fourth quarter of 2018, Bitcoin fell as much as 50 percent but gold went up almost 8 percent. A hawkish Federal Reserve and concerns of slowing economic growth due to trade tariffs were blamed for the volatility.

When stocks fell almost 34 percent in early 2020, Bitcoin fell almost 50 percent while gold traded flat.

The first three weeks of January 2022 saw almost a 7-percent decline in the S&P 500 with Bitcoin down 17 percent. Gold was flat.

“The data is clear that for now, Bitcoin is less of a hedge against inflation, and is instead a volatile risk-on asset that does well when stocks do well, and vice versa,” Business Insider reported.

Photo: The U.S. Federal Reserve on a banknote by Kurtis Garbutt / Flickr, Nov. 20, 2011, https://www.flickr.com/photos/kjgarbutt/
https://creativecommons.org/licenses/by/2.0/



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