Could Rising Interest Rates Threaten Bitcoin Prices?

It could be said that bitcoin was born in an era of low interest rates. The world's first decentralized digital currency was first mined and  traded in 2009, at a time when central banks were using unprecedented  stimulus in an effort to keep borrowing costs minimal. Following the  financial crisis, these institutions cut their benchmark rates close to  zero and engaged in asset-purchase programs in an effort to meet this  objective. Interest rates dropped sharply because of these efforts, and as a  response, investors began reassessing available opportunities  considering the low-yield environment. What did this mean for bitcoin? For one, investors found the digital  currency more compelling since the opportunity cost of foregoing  interest-rate payments was lower. In this low-rate environment, one could argue that investors saw  bitcoin as having similar incentives to other safe haven assets, for  example bonds. As long as the interest payments provided by these safe  assets were modest, investors had little reason to seek them out over  bitcoin. However, should borrowing costs push higher, the digital currency  could lose some of its luster. If interest rates start rising, it could  draw many investors away from bitcoin and into interest-bearing assets  like bonds. While the global economy has enjoyed a drawn-out period of low  interest rates, this situation might change soon. Since bitcoin doesn't provide investors with interest payments,  rising interest rates could make the digital currency less appealing to  market participants. Bitcoin's supply changes only very gradually, and  therefore any reduction in demand could prove bearish for prices. 

Rising rates a surprise

Any such change in the interest-rate environment would come as a  surprise to many, said Robert Johnson, president and CEO of The American  College of Financial Services. Borrowing costs have fallen to record lows after enjoying a steady, downward trend since the early 1980s, stated Johnson. Interest rates hit all-time highs in the early 1980s, a consequence  of Federal Reserve Chairman Paul Volcker's efforts to bring down the  high inflation that began during the previous decade. During the 1970s,  the price of a barrel of oil surged in value, which resulted in the US  economy suffering both high inflation and stagnant economic growth. Fed policymakers realized that the central bank would not be able to  fight both inflation and economic weakness at the same time, and opted  to reign in inflation. They did so by hiking the Fed's benchmark mark  rate up to unprecedented levels. Amid these efforts, the yields on 10-year and 30-year Treasuries both  hit all-time highs in September 1981, reaching 15.84% and 15.20%,  respectively. Since hitting this peak, interest rates have been following a downward trend. 

Monetary policy

The current environment of low interest rates could experience significant shifts if monetary policy becomes less liberal. If the Fed hikes the benchmark federal funds rate at its December  meeting, this move would place upward pressure on broader borrowing  costs. Such a rate hike is something Johnson believes is in the cards. "I believe that the Fed will begin raising the benchmark federal  funds interest rate following the US presidential election in November,"  he told CoinDesk. "This will initiate a series of rate hikes that will  lead to higher rates throughout the economy." Scott Tucker, a Chicago-based fiduciary investment adviser, also  pointed to the key role played by the election, stating that by waiting  until after this event to hike rates, the Fed could avoid appearing  politically motivated. The central bank is eager to increase benchmark rates after keeping them low for so long, he said. 

Low inflation

However, there are certainly factors that could hold back such a rate increase, noted Tucker. Any such developments could prove bullish for bitcoin, or at least help stem downward pressure on the digital currency's price. For starters, inflationary pressures have been modest. During the 12  months through August 2016, the Consumer Price Index for All Urban  Consumers rose 1.1%, well below the Fed’s target rate of 2%. In addition to lackluster inflation, concerns about European  economies, as well as those of Japan and China, could hinder any Fed  desires to hike benchmark rates, Tucker argued. While there are concerns  about economic strength abroad, many are also worried about US  economy's tepid recovery. "The Fed has limited scope to raise interest rates while US economic  growth remains moderate and other major economies show anemic growth,"  Brett Whysel, a financial expert who teaches Public Economics and  Decision Making at City College of New York, told CoinDesk. Whysel emphasized that raising US interest rates could prove  counterproductive by boosting the dollar, which would in turn reduce  exports and hinder the broader economy. Any potential impact on the greenback could be amplified by the fact  that both the Bank of Japan, the European Central Bank and other central  banks in that particular region have been harnessing negative interest  rate policies. This approach helps devalue their currencies, which makes their  exports less expensive relative to those of other nations such as the  US. In spite of all these reasons the Fed might have for keeping rates  unchanged at its December meeting, Whysel gave a 50-50 chance the  central bank would hike its benchmark rates at the event. 

Gradual rate hikes

Even if Fed policymakers opt to hike the benchmark rate at the  December policy meeting, the central bank's officials have repeatedly  assured market participants that any upward climb in rates will be  gradual to avoid jolting the economy. In addition, central banks that are using ultra-low interest rate  policies and negative interest rate policies may be a long ways off from  entertaining rate hikes. Once they do begin the process of raising  rates, it may take several increases before market participants feel  motivated to purchase fixed-income securities. Should bitcoin price in steady rate increases, the digital currency  may do so rather gradually, giving traders time to respond to any such  development. But, there are many other factors that could affect bitcoin prices  aside from central bank policy and its impact on broader interest rates. While low inflation could make the Fed reluctant to raise rates and  therefore reduce the odds of bitcoin prices encountering a potential  headwind, high inflation could easily prompt market participants to  flock to the digital currency as a safe haven. Bitcoin could enjoy continued draw as a safe haven should economies like Europe and Japan continue to suffer economic weakness. However, if these regions enjoy notable improvements in their  business conditions and their central banks decide upon rate hikes,  these two could provide bitcoin prices with combined headwinds. But, thus far, bitcoin has had more than seven years to gain adoption, overcome its challenges and rise in price.