Understanding how macroeconomic factors affect Bitcoin’s price

How and why did this correlation arise?

There is a belief that the crypto market began to show a correlation with the stock after the arrival of institutional investors. And it makes sense, as companies that previously used a certain investment strategy in the stock market are now applying it to cryptocurrencies. And their decisions, as we know, are primarily based on macroeconomic indicators. 

These effects were more evident during the significant shifts in the global economy associated with the coronavirus pandemic. In 2020, to prevent the severe economic consequences of lockdowns, the US government decided to ease monetary policy and turn on the printing press, despite the potential for significant inflation (which did indeed occur). It is worth noting that everything is mainly based on the US statistical data, as it is the world's first economy.

US Federal Reserve interest rate chart Source: Investing.com

It was in 2020 that the US Federal Reserve significantly cut its discount rate (by 100 basis points) and kept it at 0.25% until the end of 2021. More and more money has been flowing through the market over this entire period, resulting in a significant rise in the stock and cryptocurrency markets. However, inflation also increased. In fact, it reached the highest levels in the last 40 years. One could say they went a little too far.

Below are charts of the S&P 500 and Bitcoin from 2020 to the present day. So, in 2022, we may see a much steeper drop in the Bitcoin price. Firstly, because it's a more volatile asset, and secondly, due to factors within the cryptocurrency market, such as the Terra Luna collapse and the FTX downfall.

S&P 500 chart Source: Trading View

Bitcoin chart Source: Trading View

The art of anticipation

The main regulatory impact on inflation is the Fed's monetary policy. Inflation, meaning the value or amount of money in circulation, is regulated by lowering or raising the federal funds rate (basically the interest rate on loans). The higher the federal funds rate, the more expensive money becomes, and accordingly inflation decreases. Conversely, lowering the federal funds rate leads to the release of money and an increase in inflation. 

It may seem logical that every time the Federal Reserve announces a hike in the interest rate, the price of Bitcoin should drop, as this means less money will flow into the market. However, often the cryptocurrency experiences only a small (for the crypto market) turbulence and its price stabilizes very quickly. This is because the price of Bitcoin is now determined much earlier based on other economic indicators. In other words, there is a game of anticipation taking place. On the other hand, the reaction to the interest rate announcement is a pre-reaction of the market to what might happen due to the actions of the Federal Reserve. So it's a double game of anticipation.

US CPI chart Source: Investing.com

To understand how this works, it is necessary to comprehend what factors the Fed considers when setting the discount rate. The Federal Reserve relies on complex mathematical models and takes into account a variety of macroeconomic indicators. However, the regulator pays the most attention to the Consumer Price Index (a measure of inflation) and the unemployment rate. If prices are steadily rising, then the Fed will raise the discount rate, but within reasonable limits to avoid a high level of unemployment. Therefore, if the labor market is strong enough, the Fed will not hold back. As a result, while deciding whether to purchase or sell Bitcoin, market makers consider these and other economic parameters such as GDP.

In addition, major players in the cryptocurrency market closely follow the statements of the Fed Chair. If the rhetoric becomes “hawkish” ?, expect further rate hikes, and if “dovish” ?️, there will be a softening of monetary policy. Another option is to attempt and figure out where the Federal Reserve may stop.

Things are tough

So, we can conclude that macroeconomic factors do indeed have an impact on the price of Bitcoin, but this influence is not absolute. The cryptocurrency market has many of its own factors, some of which were mentioned in the first section of this article. Currently, much depends on international policies aimed at regulating cryptocurrencies, especially after the difficult bear market of 2022, which was filled with negative events. 

Bitcoin is still a rather volatile asset exposed to manipulation. In most cases, these manipulations are unpredictable. For example, price movements can go “against the crowd”, leading to the liquidation of traders' positions, which in turn further drives the price in the opposite direction. We described a similar situation in our article about the unexpected rise of Bitcoin.