Impending Federal Reserve Rate Cuts and Their Impact on Risk Assets

Impending Federal Reserve Rate Cuts: Implications for Risk Assets

Friday’s U.S. jobs report has set the stage for the Federal Reserve (Fed) to potentially initiate interest rate cuts, with expectations that the first reduction may occur as early as next week. According to 10x Research, this anticipated easing of liquidity could open a challenging chapter for risk assets, including cryptocurrencies.

Market analysts suggest that if the Fed opts for a significant cut of 50 basis points (bps) on September 18, it could trigger a wave of concern among investors. Rate changes are often communicated in basis points, where one basis point equals 1/100 of a percentage point. Central banks, such as the Fed, typically implement changes in increments of 25 basis points. However, larger adjustments are occasionally made to address urgent economic conditions. For example, during the tightening cycle of 2022, the Fed executed multiple increases of 50 bps and even 75 bps to rein in inflation, which led to heightened risk aversion across financial markets.

A 50 basis point cut next week could signal deeper economic worries or indicate that the Fed is falling behind in its efforts to mitigate a looming economic slowdown. This scenario may compel investors to reduce their exposure to risk assets like bitcoin (BTC) and equities. Markus Thielen, the founder of 10x Research, noted in a recent client communication, “While a 50 basis point cut by the Fed may reflect serious concerns in the market, the Fed’s primary objective will still be to manage economic risks rather than react to market sentiments.” Thielen had previously predicted BTC’s rally to $70,000 in the first quarter, showcasing his market insight.

As of now, the Chicago Mercantile Exchange’s (CME) FedWatch tool indicates a nearly 30% probability that the Fed will implement a 50 basis point reduction, adjusting rates to the 4.75%-5% range next week. Thielen observed, “The likelihood of a 50 basis point cut stands at 29%, which contrasts with our perspective and the prevailing market consensus. There’s a growing sentiment that the Fed has lagged in addressing signs of weakness in the labor market, particularly after its surprise in July.”

Thielen’s perspective aligns with the views of traditional market analysts. Craig Shapiro, a macro trader, expressed on X, “The Fed is hesitant to initiate a 50bps cut because, at this juncture, the economy doesn’t necessitate such panic measures.” He elaborated that markets reliant on liquidity will likely continue to demand a 50 bps cut, and prices will adjust downward until the Fed responds with more substantial reductions.

• Shapiro emphasized the need to identify the Fed’s “put strike price,” warning that current economic conditions, coupled with elevated risk asset prices (such as stocks and credit spreads), suggest that these levels may need to be significantly lower.

Historical data indicates that the onset of a rate-cutting cycle, regardless of the magnitude of the initial move, does not invariably produce a stimulative effect on asset prices. It’s also worth noting that the anticipation of Fed easing has been a crucial factor in driving BTC’s price up from $20,000 in January 2023, raising the question of whether such a rate cut is already factored into current market prices.