Abstract

This paper examines the complex relationship between Federal Reserve policies and the cryptocurrency market, with a particular focus on Bitcoin. The analysis highlights how Federal Open Market Committee (FOMC) decisions, especially regarding interest rates, influence Bitcoin's price dynamics. These impacts, though often mediated by market sentiment and other external factors, are evident in the short term. The paper concludes by emphasizing the necessity of further research to better understand this intricate relationship and its implications for investors and policymakers.

1 Introduction

Bitcoin, since its inception in 2009, has experienced a dramatic rise in value, growing from less than a cent to over $65,000. This growth highlights the potential of cryptocurrencies as an asset class. During this period, several additional cryptocurrencies have emerged, including Ethereum (ETH), Solana, Binance Coin (BNB), and Tether (USDT), among others. However, governments and central banks continue to grapple with regulating these unique financial products. Cryptocurrencies, still in their early stages, demand incremental regulation as they evolve into a more established investment category.

Policies enacted by the Federal Reserve have significantly impacted the global economy. Over the past decade, the Fed's stance on cryptocurrencies has fluctuated, oscillating between advocating for their elimination and supporting the gradual development of cryptocurrency derivatives. This paper examines the influence of the Federal Reserve on the development of cryptocurrencies through a series of policies and decisions.

2 FOMC and Bitcoin: A Complex and Dynamic Relationship

The terms “complex” and “dynamic” aptly describe the relationship between the FOMC and Bitcoin, with the FOMC exerting significant influence on Bitcoin through various channels. This influence manifests in interest rate adjustments, market sentiment, volatility, U.S. dollar fluctuations, and inflation expectations. Among these, interest rate changes are particularly impactful, as a key indicator of prevailing economic conditions and policy direction. The future trajectory of the U.S. dollar is also critical in shaping broader market trends. In the following chapters, we will explore these factors to elucidate how the FOMC affects Bitcoin price movements and the broader implications for global investment.

In general, the relationship between FOMC and Bitcoin can be affected by multiple factors. For instance, unstable and unexpected international geopolitical events will have a significant impact on Bitcoin itself. Bitcoin’s market sentiments, investors’ psychology, and behaviors could be major factors to impact the price. We contend that the FOMC will significantly impact the macroeconomic landscape, particularly at the national level, with a particular focus on the fluctuations of the US dollar. Nevertheless, at the microeconomic level, the term "speculators" more accurately describes the role of most investors, who follow the trend of investing in cryptocurrencies. This elucidates the interconnection between the FOMC and Bitcoin, which was previously delineated in the preceding two terms.

3 Evidence and Data Analysis

This section examines the impact of the FOMC on Bitcoin's price action from a technical perspective. It considers three key factors: the interest rate decision, market sentiment, and time-period price volatility analysis. Collectively, these three factors offer insight into the broader trend following the FOMC meeting. They can be integrated with interest rates and the dollar index to facilitate a comprehensive assessment of asset allocation.

3.1 Interest Rate Decision

The FOMC's decisions on interest rates directly influence the cost of borrowing money. The 12 members of the FOMC regularly meet eight times in each calendar year, but they can meet more often if the need should arise, to discuss whether there should be any changes to near-term(current) monetary policy. When the FOMC raises interest rates, it becomes more expensive to borrow money, which can reduce liquidity in the market. This often leads to a decrease in investments in riskier assets like Bitcoin. Conversely, when the FOMC lowers interest rates, borrowing becomes cheaper, increasing liquidity and encouraging investment in higher-risk assets, including cryptocurrencies

Figure 1 illustrates the FOMC meeting counts since 2019, the FOMC held multiple meetings to discuss the money policy during 2019 and 2020, and the price of Bitcoin fluctuated dynamically during the adjustment. The global spread of COVID-19 prompted governments to implement various policies to safeguard their respective countries. In March 2020, the FOMC convened six consecutive meetings to deliberate on the prevailing economic conditions in the United States.

Figure 1: FOMC Meeting Counts Since 2019

* Figure 1 illustrated entire meeting in 2024, only Five meeting held currently.

Data source: Federal Reserve

The price of Bitcoin experienced some fluctuation from mid-2019 to early-2020 after a series of meetings. Figure 2 illustrates the price change of Bitcoin from 2019 to 2020, it also shows the meeting date of each time and federal effective fund rate chronically. Figure 2 illustrates that following each meeting, the Bitcoin price exhibits fluctuations. These fluctuations’ frequency, magnitude, and duration contribute to the price's erratic behavior, ranging from significant increases to steep declines.

In March 2020, the FOMC held six consecutive meetings and made significant decisions regarding the federal funds rate. On March 3, 2020, the FOMC lowered the federal funds rate by 50 basis points, setting a target range of 1.00% to 1.25%. This decision was part of an emergency measure to address the economic disruptions caused by the pandemic. In a subsequent emergency meeting on March 15, 2020, the FOMC further reduced the federal funds rate by an additional 100 basis points, bringing it down to a target range of 0% to 0.25%. This aggressive move aimed to support economic activity and ensure the smooth functioning of financial markets amid escalating concerns over COVID-19. As the outbreak of pandemic and the global market reacted in 2020, Bitcoin's price fell from $12,407.33 down to $4970.79, which declined by 149.6%. In the years that followed, each adjustment in the federal interest rate by the FOMC was consistently accompanied by varying degrees of volatility in Bitcoin's price. The data from January 2021 to August 2024, which will be illustrated in the Appendix, supports this observation. While other factors can influence Bitcoin's price volatility, we suggest that a subtle correlation exists between Bitcoin and interest rates when the FOMC makes its decisions. However, this correlation is not enduring but rather temporary, typically persisting for a short period after a rate cut or hike. This transient effect may also be influenced by the prevailing international environment and economic conditions at the time.

We also computed the percentage change in Bitcoin before and after the announcements. By examining the daily returns of Bitcoin, it is difficult to ascertain if the interest rate decision has a significant impact on its price. The following figure presented the average return before and after 30 days of each FOMC announcement for each year. In comparison to the annualized average difference observed in previous years, the difference in 2020 is markedly higher. However, this is largely attributable to the exceptional circumstances of the ongoing pandemic. The average difference for the other years remains above and below 0.05, which provides no direct evidence that the FOMC's announcements had an impact on Bitcoin. Therefore, we believed there is no direct correlation between the FOMC announcement and Bitcoin price volatility. However, it is our contention that the FOMC meeting statement still exerts a certain influence, particularly with regard to future monetary policy. The allocation of global asset flows may present an opportunity for investors to invest in Bitcoin.

Figure 2: Bitcoin Average Return before and after 30 Days FOMC Announcements

Data source: Yahoo Finance, data as of August 16, 2024

Figure 3: BTC/USD and Fed Effective Fund Rate from 2019 to 2020

Data source: Yahoo Finance, Federal Reserve

3.2 Market Sentiments

FOMC meetings often lead to heightened market volatility as investors respond to updated information regarding economic conditions and monetary policy. This volatility can trigger significant price fluctuations in Bitcoin. Historical data indicates that Bitcoin frequently experiences pronounced price movements around the time of FOMC meetings, with prices typically declining in anticipation of the meeting and rebounding afterward if the announcements are viewed favorably by the market.

Our previous research highlighted the interconnectedness between market sentiment and Bitcoin, with a particular focus on the Crypto Fear and Greed Index, which offers a broad perspective on market sentiment dynamics. We analyzed the correlation between this sentiment index and Bitcoin's price movements. By comparing the daily Fear and Greed Index with the dates of FOMC meetings, we observed that market sentiment acts as a "catalyst" for the crypto market, indicating a linkage between the two. Sentiment notably shifts before and after FOMC meetings. Before these meetings, speculation surrounding potential adjustments in monetary policy predominates among investors and analysts. Institutional investors typically adjust their strategies in response to the economic climate, while individual investors tend to follow the prevailing trend – the herd mentality. Following the FOMC meetings, various interpretations of the committee's decisions prompt a wave of market adjustments, most of which are linked to interest rate decisions (3.1).

We tracked the Crypto Fear and Greed Index starting in January 2024 (Figure 4) and observed that the index typically adjusts its trend following FOMC meetings. On August 6, 2024, after the year's fifth FOMC meeting, the index hit its lowest point of the year at 17, indicating a state of extreme market fear. However, this sharp decline in the index was not directly driven by the FOMC announcement. The Federal Reserve's decision to keep the interest rate steady at 5.33% since August 2023, with a range of 5.25% to 5.5%, aligned with investor expectations and led to minimal fluctuations in Bitcoin's price. Instead, the downturn in the index and the subsequent market volatility were largely attributable to emerging geopolitical tensions, which triggered a sharp decline in Bitcoin prices.

Market sentiment is a multifaceted construct influenced by a myriad of factors, including economic indicators, geopolitical events, and technological advancements. While FOMC meetings undoubtedly play a role in shaping monetary policy and influencing market dynamics, it's crucial to recognize that they are not the sole determinant of Bitcoin's price trajectory. The interconnectedness of global markets, coupled with the unique characteristics of cryptocurrencies, introduces a complex interplay of factors that contribute to Bitcoin's volatility. A comprehensive analysis of Bitcoin's price movements necessitates a holistic perspective that considers the interplay of these diverse influences. While FOMC meetings can serve as significant catalysts for market sentiment shifts, their impact is often intertwined with broader economic and geopolitical trends. To gain a deeper understanding of Bitcoin's price dynamics, it is essential to examine the broader context and explore the multifaceted factors that shape market sentiment and drive price fluctuations.

Figure 4: Crypto Fear and Greed Index in 2024

Data source: alternative.me

Figure 5: BTC and Fed Effective Rate between 2021 and 2022

Data source: Yahoo Finance, Federal Reserve

3.3 Volatility

The volatility of Bitcoin’s price can be another measurement of the level of the FOMC meeting impacts, this is more directly reflected in the market trend. We analyzed the BTC volatility before and after 30 days of FOMC meetings since 2019 and presented the average data of Bitcoin price volatility before and after 30 days according to the FOMC meeting date.  In terms of average volatility, 2020 stands out as the most turbulent year within the past five years, recording an average volatility different of 0.5839. As we discussed in Section 3.2, the heightened market instability in 2020 can be attributed to the global COVID-19 pandemic, which prompted governments worldwide to implement a range of monetary policies aimed at stabilizing their national economies. Within this context, the first FOMC meeting of 2020 triggered the largest price fluctuations in Bitcoin between 2019 to 2024, with post-meeting volatility reaching 1.997, the highest level of volatility observed to date. These findings provide further evidence of the FOMC's influence on Bitcoin's price dynamics. Our previous research, In-Depth Analysis of Bitcoin and the U.S. Dollar Index identified an inverse relationship between Bitcoin and the U.S. Dollar Index. When the dollar strengthens, Bitcoin tends to weaken, reflecting the liquidity constraints that arise under such conditions.

The data we presented provides preliminary evidence that the FOMC exerts influence over Bitcoin's price movements. In our previous study, In-Depth Analysis of Bitcoin and the U.S. Dollar Index, we demonstrated an inverse relationship between Bitcoin and the U.S. Dollar Index. When the dollar strengthens, Bitcoin tends to weaken due to constrained liquidity. In March 2020, the U.S. Dollar Index fluctuated between 95 and 103, during which the dollar’s strength coincided with a sharp decline in Bitcoin's value (Figure 1). From 2022 onward, the U.S. Dollar Index has maintained levels between 100 and 115, contributing to Bitcoin’s decline from $47,686.81 to $16,547.49 throughout the year.  Table 1 illustrates the Average BTC volatility before and after 30 days from January 2019 to August 2024. Furthermore, the Bitcoin annualized volatility was presented in Table 2, wherein it was determined that the year 2021 exhibited the greatest volatility of the recent five years.

A thorough examination of the data presented in Tables I and II reveals that the observed volatility in Bitcoin prices prior to and following the release of FOMC meeting statements is not statistically significant. The variations between the two sets of figures were minimal, with the exception of 2020. Therefore, changes in volatility provide limited insights for investors making informed decisions. Furthermore, the correlation between volatility and market sentiment suggests that significant fluctuations in volatility are more likely to occur during periods of extreme market sentiment, either bullish or bearish. This implies that a purely technical analysis based solely on volatility may not be sufficient for accurately predicting future price movements. Therefore, while volatility is an important factor to consider in the Bitcoin market, a more comprehensive analysis that incorporates both technical and fundamental factors is necessary for making informed investment decisions.

Table 1: Average 30 Days BTC Annualized Volatility in Each Year by FOMC Meeting Date

*Data as of August 16, 2024

Table 2: Bitcoin Annualized Volatility

*Data as of August 16, 2024

4 Forecast: What Will Happen in the Rest of the Year?

On August 23, 2024, Federal Reserve Chairman Jerome Powell indicated that the central bank is poised to initiate a reduction in interest rates. This announcement, made at the Jackson Hole Economic Symposium, suggests that a rate cut is highly likely to occur in September of the current year. While the Fed had previously anticipated implementing one rate cuts by the end of 2024, recent economic data has led to a revised outlook. The central bank now expects to reduce interest rates by only 25 basis points by year-end. This decision reflects the ongoing progress in inflation and the continued resilience of the labor market. A consensus among economists and market participants is emerging in support of a September rate cut. According to a Bloomberg survey, nearly 80% of economists predict that the Fed will lower the federal funds rate to a range of 5.00% to 5.25% in the upcoming month. Furthermore, the CME Group's FedWatch Tool indicates a relatively even split between the likelihood of a 25-basis-point cut and a 50-basis-point cut. The Federal Reserve's Summary of Economic Projections (SEP) from June 2024 revealed an upward revision in inflation expectations for both 2024 and 2025.

Despite the recent progress in inflation, the economic outlook remains uncertain. The Fed has reiterated its commitment to achieving its dual mandate of maximum employment and price stability. As a result, the central bank will continue to closely monitor inflation risks and may maintain higher interest rates for an extended period. Powell's announcement at Jackson Hole has triggered a period of market volatility. Given the expectation of only one rate cut in 2024, the future actions of the Federal Open Market Committee will largely depend on economic developments in the coming months. Financial markets are anticipating additional rate cuts, with futures markets pricing in the possibility of multiple reductions by the end of the year.

5 Conclusion

Despite the observed interactions between Federal Reserve policies and cryptocurrencies, particularly Bitcoin, in recent years, it remains challenging to definitively conclude that FOMC decisions and announcements have a direct and consistent impact on Bitcoin’s price. For instance, Table 1 shows that the average volatility of Bitcoin over the past five years was 0.6606 in the 30 days leading up to an FOMC announcement and 0.6236 afterward, resulting in a volatility difference of 0.2397. However, these figures alone did not conclusively demonstrate a direct causal link between FOMC actions and Bitcoin price movements. The relationship between Bitcoin and FOMC meetings appears to be non-linear at this time, and traditional correlation analysis methods may not adequately capture the complex interplay between these variables.

Take the Bitcoin crash in early August as an example. The FOMC meeting on July 30th maintained the existing interest rate and upheld the current monetary policy. Yet, in the days following, Bitcoin’s price fell by 15.81% over a five-day period, during which global markets were gripped by heightened volatility due to geopolitical factors. This example underscores that while FOMC decisions, particularly regarding interest rates, can influence capital flows and, by extension, the cryptocurrency market, other external factors, such as geopolitical tensions, also play a crucial role in Bitcoin's price fluctuations.

Ultimately, the FOMC's decisions may serve as important reference points for those considering investments in Bitcoin, especially when interest rate adjustments are involved. Investors are advised to monitor the Federal Reserve's monetary policies as part of a broader strategy, considering that the cryptocurrency market is influenced by a complex interplay of economic, geopolitical, and policy-driven forces.

Reference:

Federal Reserve issues FOMC statement. (2024, June 12). Retrieved from Federal Reserve: https://www.federalreserve.gov/newsevents/pressreleases/monetary20240612a.htm

Mitra, M. (2024, August 13). How Low Will Interest Rates Go? Experts Predict the Fed's Upcoming Cut. Retrieved from Money: https://money.com/fed-interest-rate-cut-size-predictions/

Appendix:

Figure: BTC and Fed Interest Rate between 2023 and 2024

*Data as of August 16, 2024

Data source: Yahoo Finance, Federal Reserve

Figure: Crypto Fear and Greed Index in 2019

Data source: alternative.me

Figure: Date of Interest Rate Change and BPS

Data source: Google Gemini