The Federal Reserve’s plan to cut interest rates remains on track, boosting the outlook for cryptocurrencies and other risk assets. Recent inflation reports haven’t changed the central bank’s easing cycle. Despite some analysts’ concerns, the bigger picture shows that inflation is slowing down, giving the Fed room to lower rates next year.
In the past few weeks, the yield on 10-year U.S. Treasury bonds jumped from 3.6% to 4.1%. This happened because quant-driven fund managers shifted their investments. They moved out of fixed-income assets like bonds and into equities. As they sold bonds, bond prices fell, and yields went up. This rotation indicates confidence in the equity markets despite rising bond yields.
Stock-market pessimists are trying to convince investors that stocks can’t keep rising. They focus on short-term data and ignore long-term trends. They point to higher consumer price index (CPI) growth and strong payroll gains as reasons why the Federal Reserve can’t cut interest rates. But these arguments don’t consider the overall inflation trend, which is heading downward toward pre-pandemic levels.
The U.S. Bureau of Labor Statistics reported that September’s CPI growth was 2.4%, slightly above the expected 2.3%. While this might seem disappointing, it’s still lower than August’s 2.5% increase. In fact, September’s CPI growth is the lowest since February 2021. This shows that inflation is easing, even if it’s not as fast as some economists predicted.
When we look at the monthly growth trend on a quarterly basis, a clear pattern emerges. From January through March, the CPI increased by an average of 0.6% per month. From April through June, the monthly increase was 0.3%. In the last three months, the growth has held steady at around 0.1% per month. This steady slowdown suggests that inflation pressures are easing over time.
Over the past few years, inflation tends to run higher in the first half of the year and then slows down in the second half. In the fourth quarter of 2022, there was no inflation growth; in fact, the CPI contracted. This pattern suggests that inflation growth may slow even more in the next three months. As we move further away from the effects of COVID stimulus, economic trends are returning to normal.
Before the pandemic, from 2009 through 2019, inflation rose just over 0.15% per month. In 2021 and 2022, when inflation was surging, the average monthly growth was 0.6%, or about 7.2% per year. In 2023, the average month-over-month growth has slowed to 0.3%, or 3.6% annualized. Year-to-date, it has averaged 0.2%, or 2.4% annualized. These numbers show that the inflation trend is returning to pre-pandemic levels.
Based on these trends, inflation could fall below the Federal Reserve’s 2% target as soon as February. If this happens, the Fed will have achieved one of its main goals since it started raising rates in March 2022. This gives the central bank room to lower interest rates back to more normal levels, supporting a steady rally in risk assets like cryptocurrencies.
Another important factor is the difference between the effective federal funds rate and annualized CPI growth. Right now, that difference is 250 basis points, one of the highest levels since 2000. This means the Fed can lower rates by 2.5% before its policy stops putting downward pressure on inflation. The central bank has a cushion to ease monetary policy without fueling inflation.
Wall Street expects borrowing costs to drop from 4.9% today to 3.4% by October next year. Based on the data, the Fed has plenty of room to make these rate cuts now and still have an extra 100 basis points to work with. Lower interest rates would support a steady rally in risk assets like cryptocurrencies and stocks.
Some analysts argue that strong payroll gains mean the economy is running too hot, and easing monetary policy would fuel inflation. But policymakers have said that recent employment gains aren’t enough to change the broader employment slowdown. The job market is not overheating, and wage pressures are not driving inflation higher.
Others point to Japan’s monetary policy, saying that if Japan tightens, the U.S. can’t afford to cut rates or else U.S. bonds will become less attractive. However, Japan’s central bank has stated that the economy can’t handle rate hikes right now. This reduces the pressure on the Federal Reserve to keep rates high to compete with Japanese bonds.
Quant-driven fund managers have also influenced markets by rotating out of bonds and into equities. This has caused bond yields to rise, but it’s part of a normal market adjustment. As inflation slows and the Fed lowers rates, bond prices are likely to stabilize. The yield curve may flatten as short-term rates decrease, supporting economic growth.
The stock market has faced negativity from doomsayers who hope to drive equity prices lower. They focus on short-term fluctuations and ignore long-term trends. But the data shows that inflation pressures are easing, the economy is returning to normal, and the Federal Reserve has room to cut interest rates. This creates a favorable environment for risk assets, including the cryptocurrency market.
Cryptocurrencies often benefit from lower interest rates because investors seek higher returns in alternative assets when borrowing costs are low. As the Fed eases monetary policy, the crypto outlook improves. Investors may find crypto assets more attractive as part of a diversified portfolio. The potential rate cuts could boost the cryptocurrency market, aligning with Wall Street’s expectations.
It’s important to note that the Federal Reserve’s decisions are based on long-term economic trends, not just monthly data. The central bank considers factors like the inflation trend, employment slowdown, and global economic conditions. By focusing on these broader indicators, the Fed can set monetary policy that supports sustainable growth without triggering high inflation.
In conclusion, despite the noise from pessimists, the bigger picture shows that inflation is slowing and the Federal Reserve has room to lower interest rates. Economic trends are normalizing after the disruptions caused by COVID stimulus. The central bank’s rate cut trajectory remains intact, supporting a positive outlook for stocks and cryptocurrencies. Investors should consider the long-term trends and data rather than getting caught up in short-term fluctuations.
The Federal Reserve’s capacity to lower rates without fueling inflation provides a cushion for the economy. With inflation pressures easing, the central bank can return interest rates to more normal levels. This aligns with Wall Street’s expectations and supports a steady rally in risk assets like crypto. The relationship between interest rates and the performance of risk assets suggests that the upcoming period could be favorable for investors in these markets.
As we move forward, it’s essential to keep an eye on the inflation trend and the Federal Reserve’s policy decisions. Understanding how these factors interact can help investors make informed choices. The data indicates that the Fed’s rate cut trajectory remains intact, and the crypto outlook is improving. This information provides a basis for calm confidence in the face of market pessimism.
