Decoding Fed's Inflation & Interest Rate Signals: Bitcoin Bulls' Views

Bitcoin faced a notable decrease last Thursday, with one of its most significant drops in recent memory, which can be partially attributed to the realization that a strengthening economy implies the likelihood of rising interest rates. Instruments linked to interest rates have emerged as contenders for investor funds alongside Bitcoin.

The robust performance of consumer spending and new home sales data in July exceeded expectations, leading the Atlanta Fed’s GDPNow tool to revise its forecast to a rapid 5.8% GDP growth for the third quarter (July-Aug-Sept). Such figures are typically observed as economies emerge from recessions. In the past decade, the U.S. has witnessed such robust growth only in select quarters following the economic contraction caused by the Covid lockdown.

Bitcoin had been range-bound between approximately $29,000 and $30,000 for several weeks. However, due to the economic reports, Bitcoin experienced a drop to the low $28,000 range on Thursday afternoon. This triggered a series of stop-loss orders and liquidations, resulting in a rapid decline below $25,000. Although there has been a slight recovery since then, the price has rebounded to around $26,000 at the time of writing.

Rates Higher for Longer?

This week marks the commencement of the annual Jackson Hole Economic Symposium hosted by the Kansas City Federal Reserve, featuring a keynote address on Friday morning by U.S. Federal Reserve Chairman Jerome Powell.

Leading up to this speech, Nick Timaros, recognized as the Fed Whisperer due to his close connections within the U.S. central bank, published a column on Monday morning in The Wall Street Journal. In the column, Timaros proposed that officials within the Federal Reserve are beginning to consider the possibility that the neutral interest rate, often referred to as the rate that neither stimulates nor restricts economic growth, might be significantly higher than previously anticipated. While this might delve into technical nuances, the key takeaway is that the Fed's current benchmark fed funds target, which stands at 5.25%-5.50%, could potentially remain elevated for a prolonged period, contrary to market participants' expectations.

Considering a higher inflation target

In a recent piece featured in The Wall Street Journal on Monday, Jason Furman, who previously served as the chief economic advisor to the president during the Obama administration, shared his perspective. He advocated for the Federal Reserve to contemplate raising its inflation target from the existing 2% to 3%.

Furman elaborated on his viewpoint, stating that adopting a higher inflation target could offer additional advantages, particularly in providing a buffer to the economy during severe recessions. He explained that in times of economic slowdown, elevated inflation levels could make the option of modest price increases and wage freezes more acceptable. This, in turn, could serve as an alternative to the widespread workforce reductions that businesses often resort to in order to curtail expenses.

I agree with Jason Furman's call for a 3% inflation target — the rationale for 2% has been overtaken by a couple of decades' experience (and many of us have been saying this for a while). But ... 1/ https://t.co/qz9tQQotqS

— Paul Krugman (@paulkrugman) August 21, 2023

What it means for Bitcoin

Views may vary regarding the concepts of a elevated neutral interest rate or an accelerated targeted inflation rate, but the bond market wasted no time in responding to these developments. The yield on the 10-year Treasury bond surged by nine basis points to reach a 16-year peak of 4.34% during Monday morning.

Financial instruments linked to interest rates directly compete with riskier assets like bitcoin for investors' attention. At the margins, an increase in interest rates translates to reduced enthusiasm for bitcoin. After all, why invest in BTC when you can earn a risk-free 5% return in a 6-month Certificate of Deposit?

Conversely, if the U.S. Federal Reserve were to express a willingness to tolerate an inflation rate higher than its current target of 2%, it would signify an official recognition of monetary devaluation. This is a notion that proponents of bitcoin have consistently cautioned against.

A 3% theft target means the value of your dollar gets halved every 23 years rather than every 34 years. It's the miracle of compound theft! https://t.co/SAORdkxLNs

— Jameson Lopp (@lopp) August 21, 2023