How Do Inflation, Interest Rates, and Other Economic Indicators Affect Crypto?
Factors that drive crypto markets and Bitcoin prices are usually not the same as those that affect traditional markets. In the web3 world, key drivers include regulation, adoption, and market confidence. So, why do we often read in the news about significant U.S. Federal Reserve (Fed) announcements pushing Bitcoin prices up or down?
The thing is, cryptocurrency isn’t completely independent of centralized finance, and it’s often heavily influenced by classic macroeconomic factors. Let’s explore some of the most important indicators you might want to watch. Key Takeaways:
How CPI and Inflation Affect Bitcoin and Other Cryptocurrencies
Inflation means prices go up, and money buys less over time. The Consumer Price Index (CPI) is the key measure to keep track of inflation. It reflects changes in the cost of essential goods and services month over month.
So, how does inflation impact cryptocurrencies? You might think that as prices go up, people would stash their cash in cryptocurrencies like Bitcoin, similar to how they invest in gold. Traditionally, Bitcoin has been viewed as a safe-haven asset, but recent trends show that Bitcoin actually behaves more like the stock market than a separate safe harbor.
When inflation rises, people might not want to invest in risky assets like cryptocurrencies. High inflation typically pushes central banks to increase interest rates or tighten monetary policies to control price hikes. These measures can make traditional investments with fixed returns more attractive, and as a result, cryptocurrency prices may drop.
Interest Rates and Crypto
Periods of monetary tightening and increasing interest rates often correlate with a decline in crypto prices. However, when interest rates are low, higher-yield and higher-risk assets, like cryptocurrencies, become more attractive.
One example is the period following the 2008 financial crisis when major central banks slashed interest rates, leading to a surge in demand for speculative assets. Once interest rates rise, as they have in recent tightening cycles, the allure of cryptocurrencies diminishes.
Below is a graph from an S&P Global report that explores this connection. The blue line represents the S&P Cryptocurrency Broad Digital Market Index (S&P BDMI), which is highly correlated with Bitcoin prices. The yellow line shows the 2-year Risk-Neutral Treasury Yield, which correlates with interest rates.
The graph shows an inverse relationship between interest rates and crypto prices. For example, during the period following the onset of the COVID-19 pandemic, when interest rates were low, crypto markets flourished. As rates rose, so-called “crypto winters” occurred.
In other words, when interest rates go down, excitement in crypto goes up, and vice versa. When interest rates rise, people tend to pull back because higher interest rates mean you can get decent returns from safer places, like regular banks. As you can see, the ups and downs of Bitcoin often mirror the fluctuations in rates set by institutions like the Federal Reserve.
Unemployment Rate
The crypto industry pays close attention to this data because it may indicate the strength of the economy and the U.S. dollar, as well as the likelihood of interest rate cuts, all of which could affect the cryptocurrency market.
Here is how it works: if the announced value of the unemployment rate is higher than expected, it could mean a weaker U.S. dollar and a lower probability of interest rate hikes. As we’ve already learned, low interest rates are generally good for risky markets like cryptocurrency, so crypto prices may rise.
In June 2024, the Bitcoin price dropped sharply just after the announcement that the May unemployment rate was 4.0%, compared to estimates of 3.9% and April’s 3.9%. Because the job situation was worse than expected, it became less likely that the Federal Reserve would cut interest rates soon.
Retail Sales
When retail sales are strong, it usually indicates consumer confidence, a robust economy, and a strong U.S. dollar. A stronger dollar can make cryptocurrencies less appealing as they are seen as more volatile and risky compared to stable investments.
On the other hand, the increase in retail sales may mean consumers have extra money. They might invest some in cryptocurrencies, seeking higher returns, which can drive crypto prices up.
The impact of retail sales on cryptocurrency prices depends on current economic trends, market sentiment, and other key economic indicators.
Conclusion
Cryptocurrency markets can be influenced by macroeconomic indicators that traditionally impact the finance world. While the key factors that primarily drive crypto prices are regulatory changes and adoption rates, broader economic indicators also play a role. For example, higher inflation often leads to tighter monetary policy, which may decrease crypto prices, while lower interest rates can make high-risk investments like cryptocurrencies more attractive. Understanding these relationships is crucial for predicting how various economic conditions might impact the volatile crypto market.
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Anatol Antonovici 
Ihssan El Medkouri 
Camila Karam 