Ever since inflation began rising sharply in the middle of 2021, the world has been closely following as the world's biggest economy, the U.S., reports on this data. The Consumer Price Index, which measures the cost of goods and services, is used as the basis for inflation. It has been rising consistently throughout 2022 and 2023. In response, the U.S. Federal Reserve has increased interest rates to levels not seen since before the 2008 financial crisis.
The increase in interest rates has created a completely new environment for cryptocurrencies. As Bitcoin was introduced in 2009, the crypto markets had only ever operated in a very low interest rate environment. Having powered through the ensuing bear market, things could be looking up for both inflation and crypto investors.
Lower Than Expected CPI Inflation
The latest CPI data from the U.S. Bureau of Labor Statistics shows promising signs. The CPI inflation for June came in at 3.0% which was lower than the expected 3.1%. This is the lowest inflation number since the beginning of 2021 and just a percentage point off the Fed's target of 2.0%.
June was also the third consecutive month of declining CPI inflation as well as the first negative month-on-month print since early 2020, meaning prices between May and June actually went down slightly.
While the Federal Reserve tends to prefer the Personal Consumption Expenditure (PCE) index inflation, it and the CPI usually track each other very closely. The two numbers largely track the same data albeit weighted differently. PCE numbers will be released on July 26th. Good news all around in the fight against high inflation.
Interest Rate Cuts Incoming?
The Federal Reserve sets its rates at the Federal Open Markets Committee meetings, which are held eight times a year, the next one being at the end of this month. At that meeting, the markets expect the rates to remain unchanged.
The confidence in a federal rate cut in September, however, has increased significantly, from 65% to 80%. In a congressional hearing at the beginning of July, Federal Reserve Chairman Jerome Powell said that “It doesn’t seem likely that the next policy move would be a rate increase”. These new numbers support that claim.
Impact on Cryptocurrencies
For cryptocurrency investors this data is significant for a few reasons. Firstly, as CPI goes higher, people’s investable portion of their income gets smaller. If they have to spend more on gas and carrots, there’s not enough money left to invest in crypto. That can shrink the inflow of money into the crypto market.
Secondly, one way to fight high CPI numbers is to raise and keep high interest rates. Going from zero interest rate up to 5.5% means investors can get a decent return on risk-free investments, such as T-bills. This increases the expected return for other investments, meaning investors don’t need to move their money into perceived high-risk investments, such as crypto.
The lowered rate of inflation will leave people with more money in their wallets at the end of the month, money that can be used to invest. This could lead to a larger inflow of money into the crypto markets. If the Federal Reserve should decide to lower interest rates, the rate of risk-free return will get lower and people will have to invest in perceived higher-risk assets, such as crypto. Both lower inflation and a lower interest rate could potentially see more money coming into crypto.
What Happens Next?
The coming months will be crucial for the American economy. We’ll get the numbers for the PCE inflation at the end of this month which will give further indication on the rate of inflation in the U.S. We’re also expecting to see a rate cut at the FOMC meeting in September. Many investors will be keen to see how the market reacts to the first rate cut in over four years.
