Interest rate increases in the United States and elsewhere could weaken investors’ appetite for riskier investments, according to the International Monetary Fund’s latest World Economic Outlook report.
This warning comes at a time when record-low rates have helped push institutions (and retail investors) towards bitcoin (BTC) and other cryptoassets, indicating that a tightening of US fiscal policy may have negative blowback for the crypto market, that is considered to be more risky than traditional assets.
However, the IMF’s report suggests that the global market’s appetite for risk may not be dampened under every scenario in which the US Federal Reserve increases rates. If rises are coupled with positive news regarding the recovery of advanced economies, for example, the IMF hypothesizes that the risk aversion of international investors will remain low.
Appetite for risk
The IMF’s report dealt specifically with emerging markets (i.e. developing nations/economies), which might suggest that its findings have direct implications for bitcoin and the wider crypto market, since they deal in particular with risk tolerance.
Summing up in the conclusion to the report’s fourth chapter, the IMF’s researchers wrote:
“An unexpected signal of higher future US policy rates that is not driven by changes in economic conditions in the United States unambiguously leads to a tightening of financial conditions in emerging markets.”
In other words, significant interest rate rises in the US — in combination with a lack of good economic news — will have the effect of discouraging investors from placing their capital in emerging markets. And by extension, they might be less likely to invest in a (relatively) risky asset such as bitcoin.
As the IMF adds, banks and other institutions would seek to ‘de-risk’ their portfolios in the event that rate hikes made liquidity (i.e. money) harder to come by.
“This would potentially lead to a shift in global risk appetite, a reversal of capital flows to emerging markets, deleveraging by global banks, and a depreciation in emerging market currencies that exposes foreign exchange-related vulnerabilities.”
The report’s authors don’t attempt to quantify how much of an impact specific rises would have on investment. Nonetheless, given that bitcoin rose by a little over 1,000% in the 12 months after the Federal Reserve lowered its base rate to zero on March 15 last year, it seems hard to shake the conclusion that interest rates have played at least a part in the cryptocurrency’s historic rally.
And while rates have remained near-zero since then, it also seems quite plausible that a significant rise could make a dent in bitcoin and crypto markets.
A more favorable scenario
Fortunately, the IMF’s report isn’t all doom and gloom. While it acknowledges the possibility that rate hikes and poor economic performance could lower the market’s demand for riskier investments, it also outlines a couple of other scenarios in which rates increase but risk tolerance remains more or less stable.
“By contrast, positive news on US economic activity tends to have a relatively benign impact on financial conditions in emerging markets. The VIX and risk premiums on emerging market bonds fall, while capital tends to flow into emerging markets,” they say.
Given that the US economy has enjoyed some positive economic news recently — the addition of 916,000 jobs in March, the administering of COVID-19 vaccines to nearly 100 million Americans — such a scenario now seems quite probable. So while rate rises are becoming likelier (particularly as inflation ticks upwards), economic recovery will help maintain a balanced attitude towards risk.
As reported, in March, the Fed decided to keep the target range for the federal funds rate at 0 to 1/4 percent and said it expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with their assessments of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time.
Possibly, the rug isn’t going to be pulled from under bitcoin or crypto’s feet just yet.
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