What Does the Fed's New Stance Mean for Bitcoin and Cryptocurrencies? Detailed Analysis

Assessments are strengthening that a new division of labor in monetary and borrowing policy may take shape in the U.S. Fed Chairman Kevin Warsh's hawkish messages against inflation at Jackson Hole last night, along with Treasury Secretary Scott Bessent's steps to increase liquidity in the long-term bond market, have led to comments that the two institutions are trying to balance the market through different channels.

This scenario is closely monitored by the Bitcoin and cryptocurrency markets, which are sensitive to interest and liquidity conditions. The Fed's shift towards further interest rate hikes stands out as a development that could exert pressure on risky assets in the short term, while increased predictability in monetary policy and a reduction in liquidity issues in the bond market could create a more balanced market environment in the medium term.

In his speech on August 28 at Jackson Hole, Warsh stated that the 2% inflation target is "definite and fixed." He noted that short-term interest rates are the Fed's primary policy tool and expressed that further steps may be necessary unless confidence is established that core inflation is clearly and rapidly moving towards the target.

According to the data shared by Warsh, the PCE price index increased by 3.7% over the last 12 months, while the annualized increase over six months was slightly above 4%. He mentioned that the more positive data from the summer did not indicate a significant improvement in core inflation trends.

In contrast, Warsh pointed out that the unemployment rate at 4.1% is consistent with full employment and argued that overall financial conditions are not restrictive.

Following the speech, the U.S. two-year Treasury yield rose more sharply compared to long-term bonds. The market's probability of a 25 basis point rate hike at the FOMC meeting on September 15-16 increased from 35% to a range of 57-60%.

This change poses a significant short-term risk for the Bitcoin and cryptocurrency markets. Higher interest rate expectations could reduce investors' appetite for risky assets, potentially increasing volatility in cryptocurrencies. Particularly, whether the Fed will actually raise rates at its September meeting and the messages it will convey for the subsequent period could be decisive for the market's direction.

However, CICC believes that the rising probability of a rate hike should not be viewed entirely negatively for the markets. According to the institution, the current markets lack policy discipline and predictability more than liquidity. Timely control of inflation and strengthening the Fed's credibility could create more stable market conditions in the medium term.

While the Fed focuses on short-term interest rates, the U.S. Treasury is trying to increase liquidity in the long-term bond market. The Treasury Department announced that it would increase the size of liquidity-supported buybacks in 10-20 year and 20-30 year bonds from $2 billion to at least $4 billion per operation.

This approach implies that the long-term bond supply pressure that may arise from the Fed's balance sheet reduction could be balanced by buybacks or lower long-term issuances by the Treasury.

The main commentary emerging in the markets suggests that a de facto division of labor may form between the Fed and the Treasury.

Accordingly, while the Fed tries to control inflation and inflation expectations through short-term interest rates, the Treasury can manage market liquidity and supply pressure through its long-term bond buyback and issuance policy.

This dual structure could have a two-fold effect for Bitcoin. The Fed's tighter monetary policy may limit risk appetite in the short term. Conversely, the Treasury's efforts to reduce liquidity issues in the bond market and prevent sudden disruptions in financial conditions could serve as a balancing factor for risky assets, including the cryptocurrency market.

There is no formal agreement in this direction between the two institutions. However, the "Treasury-Fed agreement" idea that Warsh previously raised indicates that the balance sheet policy and the Treasury's borrowing plans could be made more compatible.

In the short term, the main risk facing the cryptocurrency market is the renewed strengthening of the rate hike probability. The Fed maintaining high rates for a longer period or implementing another hike could exert pressure on capital directed towards risky assets, including Bitcoin.

However, the current scenario is not solely about interest rates. As CICC has pointed out, the issue of policy discipline and predictability stands out more than liquidity shortages in the markets. A clearer framework from the Fed regarding inflation and the Treasury's efforts to reduce liquidity issues in the long-term bond market could reduce uncertainty in the medium term.

Therefore, in the short term, the Fed's hawkishness will be crucial for Bitcoin, while in the medium term, whether inflation can be controlled and whether liquidity can be maintained in the financial system will be more decisive.

The most significant development on the horizon for the markets will be the FOMC meeting on September 15-16. Although Warsh did not promise a rate hike, he significantly increased expectations that the Fed could tighten again if inflation does not decline sufficiently.

If the Fed can control inflation while the Treasury reduces pressure in the long-term bond market, a more predictable financial environment could emerge. However, if interest rates continue to rise and tight monetary policy persists, short-term pressure on the Bitcoin and cryptocurrency markets is expected to continue.