The formula seems simple. The Fed lowers interest rates, causing institutions, businesses and retail to borrow money cheaply, stimulating the economy while increasing global liquidity and pushing stocks and crypto to new all-time highs.
That’s the short story, it can’t be that simple. And in fact it isn’t. But yet social media is full of it.
In this article I explain that there are many more important metrics than the rate cuts alone, I’ll give you a look at the history and correlation between the Fed’s interest rate cuts and the economy and especially the impact on stocks and crypto.
The formula of FED Rate Cuts
A simple formula is going to pump Stocks and Crypto to new heights: ⇒ FED Rate Cut ↓ ⇒ Liquidity↑ ⇒ Economic Growth↑ ⇒ Stock Prices & Crypto Prices ↑.
While FED rate cuts are a significant factor, multiple other metrics and variables influence the surge in stocks and crypto prices. These are:
- Inflation Rates;
- Economic Growth (GDP);
- Corporate Earnings;
- Labor Market Data:
- Bankruptcy Figures;
- Liquidity in the Market;
- Monetary Policy including Quantitative Easing;
- Geopolitical Stability;
- Supply and Demand Dynamics;
- Interest in Alternative Assets.
- Market Trends and Technical Analysis.
This list of metrics highlights that the reality is much more complex than the oversimplified formula often shared on social media. While it does not cover every available metric, I think these are the most crucial factors to consider.
The most crucial metrics explained
As mentioned earlier, there are additional metrics that impact the rally in stock and crypto prices. Let’s look at each of these statistics in more detail.
Inflation rates
High inflation erodes purchasing power and may lead central banks to increase interest rates. In contrast, controlled or lower inflation supports economic growth. High inflation often results in market volatility, while stable or lower inflation generally fosters a more supportive environment for markets.
On the other hand, lower interest rates decrease borrowing costs, stimulating investment and spending, which can boost stock and crypto prices. Lower rates also make alternative assets, such as stocks and crypto, more appealing compared to bonds, which offer reduced returns.
Economic Growth (GDP)
A growing economy enhances corporate earnings and strengthens confidence in the stock market. Similarly, in the crypto space, a thriving economy can elevate investor sentiment and increase adoption. Higher GDP typically signals rising corporate profits, which can drive up stock prices. Additionally, economic confidence often leads to greater interest in alternative assets such as cryptocurrencies.
Corporate Earnings
Strong earnings reports are a major driver of stock prices. When companies report earnings that exceed expectations, it often leads to a surge in their stock prices. Since stocks are frequently valued on their anticipated future earnings, positive earnings reports or forecasts are essential for driving stock price increases.
Labor Market Data
Robust employment figures typically signal a healthy economy, resulting in increased consumer spending and higher corporate earnings. Elevated employment levels can drive up stock prices as companies benefit from a stronger consumer base. Although the direct effect on cryptocurrencies might be less significant, a strong labor market enhances overall economic stability and investor confidence, which can indirectly support the crypto markets.
Bankruptcy
High bankruptcy rates can signal economic distress, potentially leading to stock market declines as investor confidence wanes and companies face financial difficulties. Conversely, a decrease in bankruptcy rates can be seen as a positive sign of economic recovery and stability. In the crypto space, bankruptcy figures might not have a direct impact, but they can influence overall market sentiment. For instance, a wave of bankruptcies in traditional sectors might drive investors towards alternative assets like cryptocurrencies for perceived safety or speculative opportunities.
Liquidity in the Market
High liquidity, particularly from institutional investors or through quantitative easing, can infuse significant amounts of money into stocks and cryptocurrencies, driving up their prices. Liquidity reflects how easily assets can be bought or sold without impacting their price. Greater liquidity means more money is circulating in the market, increasing the flow of capital into these assets.
Monetary Policy including Quantitative Easing
When central banks implement quantitative easing (QE) by buying government bonds and other assets, it injects liquidity into the economy, which can lead to higher asset prices. QE typically boosts both stock and crypto prices by expanding the money supply.
Geopolitical Stability
Political events—such as elections and wars—can influence investor confidence. Typically, political uncertainty leads to risk aversion, negatively impacting both stocks and cryptocurrencies. During periods of instability, investors often flock to safe havens like gold and bonds, which can hurt stock and crypto prices. However, when stability is restored, risk assets like stocks and cryptocurrencies often experience a surge.
Supply and Demand Dynamics
In the crypto market, limited supply (e.g., Bitcoin) combined with increasing demand—driven by factors such as institutional adoption, retail interest, and DeFi—tends to drive prices higher. Bitcoin’s fixed supply and halving cycles, for instance, exert upward pressure on prices when demand grows.
Interest in Alternative Assets
When traditional investments such as bonds or real estate offer lower returns due to low interest rates, investors often shift towards higher-risk assets like stocks and cryptocurrencies. With fewer appealing safe-haven options, investors are more inclined to invest in riskier assets, driving up demand and prices.
Market Trends and Technical Analysis
In both stocks and cryptocurrencies, technical indicators such as moving averages, the relative strength index (RSI), and support/resistance levels can signal potential buying or selling opportunities. Traders rely on these metrics to forecast future price movements, which can drive market momentum in either direction.
History of rate cuts and impact the economy
After studying the history and the historical events of recessions combined with rate cuts I came to the following events which are explained below.
1970s Stagflation
- Initial Rate Cuts: The Federal Reserve cut rates in an attempt to stimulate growth and combat high unemployment, but these cuts were not effective in addressing the rising inflation.
- Stock Market Performance: The stock market experienced stable conditions initially but began to struggle as inflation surged. The combination of high inflation and economic stagnation led to prolonged poor performance throughout the 1970s.
- Labor Markets: Before stagflation, the labor market was stable. However, rising inflation led to increased unemployment, creating a challenging environment of both high inflation and high unemployment.
- Company Bankruptcies: Rising inflation and economic instability resulted in a notable increase in bankruptcies. Companies faced financial difficulties due to higher input costs and reduced consumer demand.
1974 Oil Crisis
- Initial Rate Cuts: The Fed cut rates in response to the economic slowdown caused by the oil crisis, but these cuts were insufficient to counteract the economic disruptions.
- Stock Market Performance: Prior to the crisis, the stock market had been growing, but the onset of the oil crisis led to a sharp decline in stock prices due to inflation and economic uncertainty.
- Labor Markets: The labor market was stable before the oil crisis but deteriorated as the crisis caused economic disruptions, leading to higher unemployment and job losses.
- Company Bankruptcies: The oil crisis resulted in a significant rise in bankruptcies, especially among industries heavily reliant on oil and energy. The increase in oil prices and the economic slowdown put many companies under financial stress.
1980 Energy Crisis and Tightening Monetary Policy
- Initial Rate Cuts: Initially, the Fed cut rates to stimulate the economy, but the persistent high inflation led to the adoption of tight monetary policies, which eventually contributed to a severe recession.
- Stock Market Performance: Before the energy crisis, the stock market was facing challenges due to inflation. The energy crisis and subsequent tightening of monetary policy led to a sharp decline in stock prices, reflecting economic strain.
- Labor Markets: The labor market was struggling from the previous recession, with rising unemployment. The energy crisis exacerbated these issues, leading to higher unemployment rates and economic hardship.
- Company Bankruptcies: The late 1970s and early 1980s saw a significant rise in bankruptcies as businesses struggled with high energy costs and inflation. The economic instability made it difficult for many companies to sustain operations.
2008 Financial Crisis
- Initial Rate Cuts: The Federal Reserve cut rates aggressively in response to the emerging financial crisis, aiming to inject liquidity into the economy. However, these cuts were insufficient to prevent the severe economic downturn.
- Stock Market Performance: Prior to the crisis, the stock market was experiencing a prolonged bull run. The onset of the crisis caused a dramatic and severe decline in stock prices, with major indices losing significant value due to the collapse of financial institutions and widespread panic.
- Labor Markets: The labor market was relatively strong before the crisis, but unemployment surged dramatically as the crisis unfolded, leading to significant job losses and economic contraction.
- Company Bankruptcies: The financial crisis led to a sharp increase in bankruptcies, particularly among financial institutions and real estate companies. The collapse of major firms like Lehman Brothers and the ripple effects caused widespread financial distress and bankruptcies.
COVID-19 Pandemic (2020)
- Initial Rate Cuts: In response to the economic disruption caused by the pandemic, central banks, including the Federal Reserve, cut interest rates to near-zero levels to support the economy.
- Stock Market Performance: Before the pandemic, stock markets were performing well with strong gains. The pandemic caused a sudden and dramatic decline in stock prices due to uncertainty and economic disruptions. However, the markets quickly rebounded following substantial fiscal and monetary stimulus, reaching new highs later in the year.
- Labor Markets: The labor market was strong before the pandemic, but the onset of COVID-19 caused a severe spike in unemployment as businesses shut down or reduced operations. The labor market faced significant challenges during the early stages of the pandemic.
- Company Bankruptcies: The pandemic led to a notable rise in bankruptcies, particularly among businesses in travel, hospitality, and retail sectors. Economic shutdowns and reduced consumer spending placed significant financial pressure on many companies.
Events where the rate cuts saved or actual recovered the economy are:
1. Post-World War II Economic Boom (1945–1950s)
2. The Early 1990s Economic Recovery (1990–1994)
3. Post-2001 Dot-Com Bubble Recovery (2001–2004)
4. Recovery from the 2008 Financial Crisis (2009–2015)
5. Post-COVID-19 Pandemic Recovery (2020–2021)
It’s notable to see that these periods were actual post-recession events.
Level of rates before the economy to collapse
We know that the economy can still collapse even after the Fed has cut rates. To explore this further, it would be insightful to analyze the interest rates that were in place before these cuts to determine if there are any notable patterns or insights. They were as followed:
- 1970s Stagflation: 5-9%
- 1974 Oil Crisis: 10-12%
- 1980 Energy Crisis: 19-20%
- 2008 Financial Crisis: 5.25%
- 2020 COVID-19 Pandemic: 1.50-1.75%
What stands out is that the rates have been down trending by time and that they never saw higher rates than approximately 6.5% since the year 2000. Since the year 2000 we only have seen one significant period of a bad economy and that was during the Financial Crisis in 2008. The Pandemic in 2020 was a flash crash in my opinion which recovered massively after cutting the rates in a short period, with a high pace. One could argue that the Fed appears to have gained greater control over economic management over the years compared to earlier periods.
However, history demonstrates that rate cuts alone are not always sufficient to prevent economic collapses. Since 2000, peak interest rates before cuts have steadily declined, potentially limiting the Fed’s ability to respond to future crises. While rate cuts, such as those during the 2020 pandemic, can offer relief, factors like inflation, external shocks, and structural imbalances tend to have a larger impact on economic outcomes. The Fed’s tools may face limitations.
Current state of the economy and the outlook
Having explored the crucial impact of these metrics and the impact of the FED cutting rates, it’s now time to examine the current state of the market and the important metrics.
How will the FED rates, which will likely to be cut this month, affect the market?
Finding the correlation between several metrics
In this analysis I have tried to find the correlation between the FED rates, global liquidity, stocks and crypto (Bitcoin).
I did not only look into the current timeframe but went all the way back to the birth of Bitcoin. What I found out is the following:
1. There is a correlation between the global liquidity and stocks and crypto prices;
2. There has been a growing correlation between stocks and Bitcoin since 2019/2020.
Correlation with the Global Liquidity, stocks and Bitcoin.
The correlation between these are pretty clear, but what stands out is that stocks and crypto lagging behind on the growing liquidity. Once the FED cuts their rates global liquidity will rise. But the impact of the stock and crypto market is lagging. This works both ways.
Correlation between stocks and bitcoin is growing
While Bitcoin is getting more “mature” there is a growing correlation between Bitcoin and Stocks. In Bitcoin it’s early days Bitcoin was often the opposite trade compared to the traditional markets. But since 2019/2020 this changed. Stocks were often the leading indicator. When they trended down Bitcoin came down along. While Bitcoin has shown more correlation with stocks, it’s not a perfect match. There are still periods where Bitcoin can move independently due to crypto-specific factors such as the halving events.
Unemployment & bankruptcy data
After analyzing the unemployment data and bankruptcy data I found concerning metrics. The unemployments numbers have been growing significantly. Looking at the chart of the Bureau of Labour Statistics as shown below it’s clear that the unemployment’s rates have grown. What I see is that every time it rose in history it eventually lead to a much bigger unemployment rate. I find that pretty much concerning.
Looking at the bankruptcy numbers it’s notable that bankruptcy numbers have been growing since 2021. The bankruptcy numbers during the pandemic in 2019 and 2020 were also high but dropped significantly into 2022. During the pandemic the FED cut the rates significantly. That shows a possible correlation with the rates and the numbers of bankruptcy. This is a positive sign leading into the rate cuts.
Conclusion:
Rate cuts are typically implemented to slow down rising unemployment rates and bankruptcy numbers, signaling that the economy is facing significant challenges. However, the impact of rate cuts is not immediate. It often takes time for the effects of cheaper borrowing to filter through the economy and lead to meaningful improvements. While rate cuts may eventually stabilize the labor market and reduce financial distress, their success depends on how responsive the broader market is to these adjustments.
For crypto, a potential rally could be on the horizon, but it may take a few months for momentum to build, as the effects of the rate cuts slowly take hold. Stocks, on the other hand, appear overbought on higher timeframes, suggesting that the recent dip may continue for some time before recovery. Although it might seem like an opportunity for crypto to decouple from traditional markets, history has shown a growing correlation between Bitcoin and stocks, particularly since 2020. Therefore, any sustained recovery in crypto will likely remain tied to broader market conditions in the near term, though a temporary decoupling remains possible.
In summary, while rate cuts provide short-term relief and support for markets, the road to recovery may be gradual, particularly in stocks, while crypto could see renewed interest but may remain influenced by overall economic trends.
