The Federal Open Market Committee (FOMC) is one of the key components of the United States Federal Reserves as they hold one of the major responsibilities of devising the monetary policy of the country. The Committee comprises top financial experts and policymakers. Its responsibility is to take a comprehensive look at the economic policies of the government to make plans on what these policies should state.
Through interest rate adjustments, asset purchases, and forward guidance, the FOMC seeks to maintain economic stability by controlling inflation and promoting employment. The FOMC meeting is held at least eight times a year to review economic and financial conditions.
In recent years, we have seen an exponential rise in the popularity of the cryptocurrency. We don’t need to delve much into how crypto has become popular since those who follow the crypto space know about its decentralization nature, its potential return on investments, and several other factors attributed to it. As traditional markets grappled with economic uncertainties, crypto emerged as an enticing alternative asset class, drawing both retail and institutional investors into its fold.
If you are new to the world of cryptocurrency and haven’t heard of the FOMC before, then you would certainly know about what they do now. The reason why crypto traders and investors look at what FOMC has to say is that their decisions not only drive the prices of assets in the stock market, but they are also instrumental in driving the prices of crypto assets as well.
We will look into this complex relationship between the FOMC and the crypto market and explore how the decisions of the FOMC have affected the crypto market and why, every time the FOMC is about to make an announcement, the whole crypto market waits to hear their next statement and derive their conclusion for creating new strategies accordingly. As FOMC decisions impact interest rates, economic indicators, and investors’ behavior in the traditional market, the crypto market is not immune to those same outcomes.
Understanding the FOMC: Shaping the Heart of U.S. Monetary Policy
To understand how and why the FOMC’s policies impact the crypto market, we will first try to learn the inner workings of this financial institution.
Composition and Functions of the FOMC
The Federal Open Market Committee is composed of twelve members. The group includes the seven members of the Board of Governors, the President of the Federal Reserve Bank of New York, and four other Reserve Bank Presidents, who serve on a rotating basis. The reason why we have such a diverse group of people working together to form a financial policy is that with different expertise comes different sets of opinions, which will help in making a strategy that will be beneficial for all.
The main function of the FOMC is to guide and implement the monetary policy in the United States. One of the most important tasks of the Committee is to set the federal fund rates, which are interest rates at which banks lend to each other overnight. The federal fund rates are responsible for impacting the borrowing costs for businessmen and consumers, which in turn influences the spending, investment, and economic growth of a country.
Mandate: Inflation and Employment
The two main objectives of the FOMC are to manage inflation and promote employment in the country. Inflation is the gradual increase in the prices of goods and services in the economy. The FOMC’s job is to keep inflation in check to ensure price stability, as this is vital for economic predictability and the purchasing power of the consumer. The second objective (promoting employment) is also an extremely important task for the Committee as keeping the unemployment numbers low helps ensure a positive sentiment in the economic market of the country. Maintaining a positive sentiment and low unemployment numbers will help the economy to thrive.
Tools of Monetary Policy
The FOMC has a list of tools that it can use to manage the economy effectively. They are:
Open Market Operations:
The most often used tool by the Committee is the Open Market Operations. How it works is that it involves the buying and selling of U.S. Treasury securities. When the FOMC buys securities, it injects money into the banking system, which in turn lowers the interest rates. As a result, it helps the financial market get more investments. Conversely, when the FOMC sells securities, it is withdrawing money from the system. The result of this practice is that we see an increase in interest rates, and the market activity slows down accordingly.
The Discount Rate:
The discount rate is the interest rate at which banks can borrow money from the Federal Reserve. By changing this rate, the FOMC can encourage or discourage banks from borrowing and thus influence lending and borrowing rates in the broader economy.
Forward Guidance:
The FOMC uses its statements and communications to provide forward guidance to the financial markets and the public. The language and signals in these statements can have a significant impact on market expectations, influencing investment decisions and asset prices. A hawkish tone would indicate to the market that tougher times are coming ahead, and they would try to avoid putting money on risky assets. A positive tone would give signs of upcoming progression in the market, which in turn would increase investor’s confidence in the market.
The FOMC’s Influence on Conventional Markets
Before discussing how the decisions made by the FOMC affect the crypto market, we will first look at how their choices have an impact on the traditional financial markets, which include stocks, bonds, and other established investment options.
The FOMC has the authority to decide interest rates, particularly the federal funds rate, which has a direct impact on various other interest rates. When the FOMC changes the interest rates, they affect the lending and borrowing decisions of the market. The effect is not only limited to individual levels or institutional levels but can have an impact on the government level as well.
Stocks:
When the FED lowers the interest rates, they are trying to make market conditions more suitable for economic activities and have seen that the market reacts positively to such news. Companies start to invest more capital towards expansion to make more profits.
To achieve this goal, they need to hire new skilled workers, which means that employment opportunities are going to increase as well. The other thing that will be impacted by the company’s desire to expand their portfolio is that their stock prices will also increase because investors want to get in on that action as well.
The opposite scenario to this will be when the FED increases the interest rates, borrowing becomes more expensive, and as a result, the profit margins of many companies also take a hit. The stock prices will fall as a result of decreased profits, and some organizations will be forced to let go of a certain number of employees if conditions don’t improve soon.
Bonds:
Bond prices and interest rates move inversely. When the FOMC lowers interest rates, existing bonds with higher yields become more attractive, causing their prices to rise. Conversely, rising interest rates can diminish the value of existing bonds, potentially leading to losses for bondholders.
Example of FOMC Actions Impacting Traditional Markets
One example where we have seen FOMC’s decision impacting the traditional market was back in the financial crisis of 2008. The 2008 financial market crisis caused great recession and instability in the market, along with the crashing of the stock market, the housing market getting hammered, and unemployment rates increasing exponentially.
After the dust settled, the FOMC took steps to deal with the fallout of the market crash. They decreased the interest rates dramatically and introduced quantitative easing that involves the central bank purchasing a substantial quantity of financial assets, typically government bonds, and sometimes other securities like mortgage-backed securities, from the open market.
The purpose of such actions was to stabilize the economy and help it in the process of recovery. This is just one example where steps taken by the FOMC have impacted the market. There are several examples where we can see the market improving or deteriorating based on the financial policy announced by the FOMC.
FOMC and the Crypto Market
Now that we have some working knowledge about what FOMC is and how it affects the traditional financial market let’s see how the crypto market gets affected by it and why the crypto market anxiously waits for the FED’s periodic announcements whenever they are due.
Interest Rates:
When the FOMC alters the interest rates, here’s a possible scenario of how the crypto market reacts to it.
When the FOMC lowers the interest rates, its goal is to encourage borrowing and spending. Lower interest rates mean that you can borrow money and pay less interest on it, thus putting less strain on your pocket, which means that you can spend more. For traditional investors, this can be a cause of doing some head-scratching. The reason for this deliberation is that investment options like bonds and savings accounts offer fixed interest rates, which makes them considered a safe investment option. When the rates are cut, this means that the returns on such investment options decrease with it.
This is not considered an ideal scenario for any investor, and therefore, they may seek some alternate option for investment. This is where cryptocurrency comes into play as not only is it considered as a hedge against inflation, but it has the potential to give back substantial returns on the investments made in it, provided you have done your due diligence and done proper risk analysis, formulated a trading strategy look at the external conditions before investing in cryptocurrency.
In 2020, the FOMC slashed interest rates to near-zero levels in response to the economic challenges brought by the COVID-19 pandemic. Traditional investments like savings accounts and government bonds began offering extremely low returns. As a result, some investors turned to cryptocurrencies like Bitcoin, which saw a meteoric rise in value as investors piled huge amounts of money into crypto to boost their investment portfolio.
The opposite scenario to this is when the FEDs announce interest rate hikes, investors see traditional investment options as more lucrative options to earn a profit, and therefore, they pull their investments from their crypto portfolios. A high number of people following this similar strategy results in prices of crypto assets decreasing.
Economic Indicators:
The FOMC pays close attention to economic indicators like unemployment rates and inflation. If these indicators are strong, indicating a robust economy, it can lead to interest rate hikes. How does this affect the crypto market?
When economic indicators suggest a healthy and growing economy, the FOMC may raise interest rates to prevent the economy from overheating. In this context, an overheating economy refers to a situation where the market is going at a pace that cannot be maintained for long. It drives inflation upwards, which causes prices of goods and services to increase rapidly, decreasing the purchasing power of the masses in the process. Also, it leads to an increased demand for raw materials and goods. When these increased demands are not met, then this also leads to an increase in costs for businesses, which reduces their profit margins.
Higher interest rates make traditional investments more appealing because you can get better returns from safer investments. When your bank offers higher interest on savings accounts, you would be tempted to pull money from your crypto portfolios and put it into your savings accounts.
The other factor that leads to this decision is that since cryptocurrency is a highly volatile market, it makes much more sense to just put money into a savings account and gain returns from it rather than risk it in a volatile market.
Example: In December 2015, the FOMC raised interest rates for the first time in nearly a decade, signaling its confidence in the U.S. economy’s recovery. This move made traditional investments more attractive, causing some investors to shift their funds away from cryptocurrencies. Bitcoin’s price dropped in response to this shift in investor sentiment.
So, we have now seen how FED’s decisions and policies can potentially impact the crypto market and why the cryptocurrency market, in particular, focuses greatly on FED’s decisions regarding rate hikes and economic indicators.
