July FOMC: What Real vs Nominal Rates Mean for Bitcoin

Last Update 07/26/2023

The FOMC raised rates again today after pausing in June. Although nominal short-term interest rates have reached their highest level since 2001, real (inflation-adjusted) rates remain moderate.
Although crypto has healed significantly since late 2022, valuations are now more closely tied to broader macro trends, and more Fed tightening could be a headwind for higher risk assets, including both equities and cryptocurrencies.

The Federal Reserve raised the funds rate target range to 5.25-5.50% today, July 26, after pausing at its meeting in June. The post-meeting statement was little-changed, again offering neutral and data-dependent guidance for policy rates. In his press conference, Fed Chair Powell offered balanced remarks, but seemed to take comfort from the fact that inflation has recently come down without requiring a rise in the unemployment rate. Markets reacted by lowering the odds of further rate hikes after September (Exhibit 1). Powell stressed that the committee had not made a decision about the September FOMC meeting, and noted they would be focused on two inflation reports and two job reports before then.

Exhibit 1: Markets lowered odds of rate hikes after September on Powell’s remarks

The nominal funds rate has now reached its highest level since 2001, and Chair Powell said the FOMC considers its current stance “restrictive” (i.e., tight enough to slow economic growth). However, in “real” (inflation-adjusted) terms, short-term interest rates are still relatively low compared to levels that were common before the 2008-09 recession (Exhibit 2). We expect that real interest rates will matter more for Bitcoin’s valuation than nominal rates.

Exhibit 2: Real short-term interest rates still moderate

Bitcoin is a unique asset, as a non-sovereign money system or currency, and the largest network in an emerging blockchain ecosystem. For both reasons, its price should be sensitive to real interest rates. Sovereign currencies tend to gain in value from nominal yield and tend to lose value from inflation (relative to other currencies). Therefore, real interest rates–i.e. nominal interest rates less the rate of inflation–are an important fundamental input into currency valuation.

Gold is a traditional non-sovereign currency (or “store of value” asset) that has no yield, and a low and roughly fixed rate of inflation. As a result, its price tends to be inversely correlated to real interest rates: when real interest rates rise, the price of gold falls, and when real interest rates fall, the price of gold rises¹. Bitcoin is much the same: a non-sovereign money system with a scarce supply. So similar to gold, we would expect Bitcoin’s price to move inversely with real interest rates.

At the same time, Bitcoin is also a key pillar of the blockchain economy, so it is often treated by investors as a frontier technology, and its price is often correlated with tech-related assets. Real interest rates also drive risky assets, in general, and tech or “growth” assets in particular, because lower real rates raise the value of more distant earnings. Because of Bitcoin’s role as both an emergent technology and an alternative money system or currency, its valuation should be expected to remain inversely correlated with real interest rates over time.

Although the Fed continues to raise the funds rate, real interest rates remain moderate. This is likely why most risky assets have appreciated and why the Dollar has fallen from its highs late last year: markets and the economy are signaling that US monetary policy, in real terms, is not actually that tight. As long as this continues, we believe there is no reason to think Bitcoin’s price can’t continue to climb, even if the Fed nudges up nominal interest rates a couple more times.

^{1. This is mainly true for US real interest rates, reflecting the Dollar’s role as the world’s primary international currency.}

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Nominal values are expressed in units of current Dollars while real values are adjusted for inflation (typically using a consumer price index).Nominal yield is the rate of return on an investment without adjusting for inflation. Real interest rates refer to the rate of return on an investment after accounting for inflation in the price of goods over the same period. Technology is defined quite broadly to include new economy companies across GICS industry groupings. Correlation is a statistical measure that quantifies the relationship between two or more assets.

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