Bitcoin Bulls Mull the Meaning of New Fed Messaging on Inflation and Interest Rates

Bitcoin suffered one of its more dramatic declines ever last Thursday at least in part thanks to the realization that a strengthening economy means interest rates are likely to stay on the rise.

Consumer spending and new home sales data for July both came in stronger than expected last week, prompting the Atlanta Fed’s GDPNow tool to up its forecast to very speedy 5.8% GDP growth in the third quarter (July-Aug-Sept).

Those sorts of numbers are typically just seen coming out of recessions and the only time the U.S. has experienced such fast growth in the last decade was in a few of the quarters following the Covid lockdown-induced economic collapse.

Stuck in a tight range roughly between $29,000 and $30,000 for several weeks, bitcoin (BTC) Thursday afternoon dropped to the low $28,000 area thanks to the economic news. That, in turn, triggered a chain of stops and liquidations that sent bitcoin quickly plunging below $25,000. A very modest recovery since has brought the price back to $26,000 at press time.

This week brings the Kansas City Federal Reserve’s annual Jackson Hole Economic Symposium and a keynote speech Friday morning from U.S. Federal Reserve Chairman Jerome Powell.

Ahead of the talk, the WSJ’s Nick Timaros – known as the Fed Whisperer for his close contacts within the U.S. central bank – Monday morning wrote a column suggesting officials believe the so-called neutral rate of interest could be far higher than previously thought. It’s a fairly wonkish subject, but the takeaway is that the Fed’s benchmark fed funds target – currently at 5.25%-5.50% – could stay a lot higher for a lot longer than market participants expect.

Also in the WSJ on Monday was a column from Jason Furman, the president’s top economic advisor during the Obama administration, in which he urged the Fed to consider lifting its inflation target to 3% from 2%.

“A higher target also has the benefit of helping cushion the economy against severe recessions,” wrote Furman. “When the economy slows, higher inflation means that price hikes and wage freezes can become a less unpalatable alternative to widespread layoffs for business looking to cut costs.”

Opinions will differ on ideas about a higher neutral rate of interest or a faster targeted rate of inflation, but it didn’t take the bond market long to react to these two pieces of news – the 10-year Treasury yield Monday morning shot higher by nine basis points to a new 16-year high of 4.34%.

Instruments tied to interest rates compete with risk assets like bitcoin for investor dollars, and – at the margin – higher rates means less interest in bitcoin, i.e., why buy BTC when you can earn 5% risk-free in a 6-month CD.

On the other hand, were the U.S. central bank to indicate a tolerance to allow an inflation rate higher than its current 2% target, it would be the sort of official acknowledgement of monetary debasement that bitcoin fans have forever been warning against.