Why Do FED Decisions Affect the Cryptocurrency Market?-banner-imageAcademy

Why Do FED Decisions Affect the Cryptocurrency Market?

The Fed or "Federal Reserve" is the full name of the US Federal Reserve. It was established on December 23, 1913. Among the other duties of the FED, one of the main purposes of which is to carry out the monetary policies of the USA;

• Ensuring financial stability and employment,

• Regulation and supervision of financial institutions.

To fulfill these duties as the financial authority in the United States, the FED uses tools, such as;

• Open market operations,

• Reserve rates,

• Discount rate and payment of interest on reserves.

In simpler terms, the FED determines the money supply and interest rates in the market. Considering the position of the US economy and the US dollar in the world, it can be said that the decisions taken by the FED have a great impact on the world economy.

The Covid-19 pandemic was not a development that could be predicted or taken action by either the country's economies or companies. With the closures and quarantine processes that started especially in China, the supply chain was disrupted in a short time all over the world. While companies had difficulty in accessing raw materials and materials, the world suddenly came to the brink of economic contraction. At this point, many central banks, especially the FED, decided to increase the money supply to solve this liquidity crisis. The graph below shows the money supply for the last 5 years. It is possible to see the sharp increase in money supply as of March 2020, when the pandemic started to show its effect all over the world.

source: tradingeconomics.com

source: tradingeconomics.com

With the increase in the money supply, the liquidity crisis was resolved for a while. Significant rises took place in cryptocurrencies and Major stock markets. Most of the technology companies have made significant gains in these processes. In particular, aid was given to households in the USA. Many news about the purchase of crypto money with these aids made the headlines at that time. Thanks to the abundance of liquidity, investments increased. However, in the current period, high money supply brought high inflation. The highest inflation figures of recent years were recorded in the USA, Europe and many other parts of the world. In addition to high inflation, the slowdown in economic growth caused the USA to contract for two consecutive quarters and entered a technical recession.

The FED, which wants to reduce the high money supply, stated that it will go to Tapering (Balance Sheet Narrowing) as of the 3rd quarter of 2021 and will start reducing its bond purchases and aiming to balance the money supply in the market by increasing interest rates. Bitcoin and cryptocurrencies, which have been in high positive correlation with traditional markets in recent years, have begun to be affected positively or negatively by these developments. The decrease in the money supply in the market meant that investments would decrease, interest rates would increase and the US dollar could appreciate. In this process, in the scenario of the appreciation of the US Dollar, the acceleration of the exit movement, which usually occurs in investment instruments such as stocks or cryptocurrencies, negatively affected the markets.

After the FED announced these decisions, as of the new year, the Nasdaq Technology Index lost approximately 38%, the S&P 500 lost 24% and Bitcoin lost approximately 48%.

While Bitcoin and cryptocurrencies have appealed to a much narrower audience in the past, as of 2020, they have become a topic that everyone talks about, takes place in the mainstream media, big companies invest and even some states accept it as legal payment unit. With its spread to a wide audience, it started to show a high positive correlation with traditional markets. For this reason, although the FED's decisions have a direct impact on traditional markets, they have also started to affect crypto money markets, especially Bitcoin.