The current European energy crisis may force the Federal Reserve to pivot on its monetary tightening regime. However, with inflation showing no signs of slowing, the crypto-currency market may still struggle to recover in any meaningful way.
Has the market hit bottom?
From the smallest retail investors to the largest hedge fund managers, this is the big question on everyone’s mind right now. The hustle and bustle of macro signals and technical indicators makes it hard to understand what exactly is going on in the economy in general, let alone the faster moving crypto market.
Several major technical indicators have issued buy signals in recent weeks, reinforcing the idea that the crypto-currency market may have bottomed out. How the crypto market reacts to macro news is worth considering. A big change came after June’s consumer price index data recorded a new high. Many market participants expected the crypto to start a new decline after this news. However, the opposite happened. Since the release of the CPI, crypto has been on the rise, putting a damper on any late short selling attempts. Likewise, Wednesday’s 75 basis point rate hike and yesterday’s negative GDP growth ironically pushed the crypto higher, indicating that the market may now have “embedded“the current downward economic trend.
Yet, even though market participants have stopped worrying about the overall macroeconomic situation, this does not mean that there is no more pain to come. The fact is that inflation is still very high and the Fed is determined to bring it down to an acceptable level. Although Fed Chairman Jerome Powell said after Wednesday’s hike that he was “become appropriate to slow the pace of increases“, he also left the door open for an increase “even greater” if necessary. The ongoing hikes, coupled with a short sale of Treasuries and Fed mortgage-backed securities, will tighten the flow of money and almost certainly put the brakes on risky assets like crypto.
The other big macro issue is the cost of energy, especially in Europe. The war in Ukraine and the resulting boycott of Russian energy has exacerbated already alarming global inflation rates. Winter is coming, and there is a real possibility that many European countries will not have the energy they need, and certainly not at a price the average citizen is willing to pay. If the embargo on Russian oil and gas continues, Europe will have to rely on the U.S. for its energy supply in the coming months.
In recent months, the euro has weakened considerably against the dollar, helped by the Fed’s rate hikes and monetary tightening. At the same time, it seems likely that European nations will have to buy U.S. energy to run their economies, putting the U.S. in a difficult position.
The U.S. has two options: take steps to strengthen the euro against the dollar by injecting liquidity into the European economy or let European countries default on rising energy costs. Keep in mind that many European countries and the European Central Bank hold foreign exchange reserves of U.S. debt, which means that if they default, the U.S. economy will also suffer.
Therefore, the Fed may have to end its monetary tightening to avoid a catastrophe in Europe. Currently, there is a window between now and winter where the US can continue to raise rates. However, Europe will soon reach a breaking point, and the Fed will be forced to relieve some of the pressure by stopping or reversing its current monetary policy, which will weaken the dollar.
Can the market go down before the Fed is forced to pivot? It will be difficult for the crypto to hit new lows soon, given the huge amount of deleveraging that caused bitcoin to fall below $18,000. But we could certainly revisit those levels if the macroeconomic situation worsens.