Central banks are starting to cut interest rates. What does this mean for cryptocurrencies?

Author: Jack Inabinet, Bankless; Translator: Deng Tong, Golden Finance

Rate cuts are coming! After two difficult years of raising interest rates to fight inflation, central banks around the world have finally begun the process of cutting interest rates! How will this development affect your portfolio in the coming months?

The Bank of Canada (BOC) cut its overnight interest rate target by 0.25% to 4.75%, the first rate cut in four years and the first loose monetary policy adopted by G7 countries in the post-epidemic era.

While Canada's Consumer Price Index (CPI) in April was slightly above the bank's long-term target of 2%, the Bank of Canada cited "persistent evidence that underlying inflation is easing" to justify its first round of rate cuts.

Despite widespread uncertainty about when the Fed will cut rates, with Barron's even boldly claiming over the weekend that there will be no rate cuts in 2024, a Bank of Canada rate cut is the base case for this meeting: swap markets have priced in an 80% chance of a rate cut.

Tomorrow, the European Central Bank (ECB) will announce its interest rate target for the coming month, and market participants are almost unanimous in believing that they will cut rates, with a 96% certainty that the ECB's rate target will be lowered by 25 basis points.

Against the Fed's headwinds in rate cuts, falling global risk-free rates have increased the attractiveness of holding U.S. dollar investments, boosting the greenback's strength, potentially reigniting inflationary pressures overseas and putting enormous pressure on U.S. monetary officials to implement their own rate cuts in the near future.

Western bloc countries, especially the G7, have shown extremely close policy consistency, meaning that the Bank of Canada and the European Central Bank are unlikely to make such major policy changes without first consulting the Fed on when it intends to cut rates.

While the CME’s FedWatch tool suggests little change in US interest rates until September, it is clear that global policymakers are coordinating lower interest rates, lighting the way towards an aggressive rate-cutting cycle.

Bulls were encouraged by this development, sending equity indices and cryptocurrencies soaring after hitting new cycle highs, although the US rate cuts were largely unexpected by the seemingly hawkish Fed, a stance that was reversed at the first sign of objectively troubling economic data.

Many data series already show that a recession has already begun, which, when combined with the emerging global trend towards loose monetary policy (especially among key economic allies), could lead to a surprise rate cut by the Fed next week.

During the global financial crisis, Federal Reserve officials slashed interest rates by 0.75% on January 22, 2008, in an attempt to revive the deteriorating economy and stem the stock market’s slide.

While these rate cuts succeeded in providing a temporary bullish tailwind for risk assets, allowing the broad-based S&P 500 to rebound nearly 15% from its lows, they unfortunately ultimately failed to have a lasting impact, with the index’s price losing half of its value by the end of the year.

The need for policymakers to cut interest rates is a harbinger of impending economic problems, and historically, the tools available to central banks have proven unable to stop the economic downturns they want to prevent.