What is the Impact of the Economic Recession on the Crypto Market?

[TL；DR]:

The recent weak data that the US economy may fall into recession has triggered panic in financial markets, leading investors to sell risky assets. The crypto market is particularly affected by global market risk aversion and has also undergone recent adjustments.

The market generally expects the Federal Reserve to cut interest rates at least twice, totaling 75 basis points, in the second half of 2024 to cope with the pressure of slowing economic growth.

The market will experience both trading decline and price cuts, which are determined by its speculative nature and value storage characteristics.

Introduction

More and more institutions predicted that the Federal Reserve would cut interest rates in September, but this potential benefit was quickly overwhelmed by investors’ fear of a US economic recession, with Bitcoin, Ethereum, and even experiencing significant declines on August 5th.

This article will explore the complex and contradictory situation faced by the crypto market during the US economic recession.

Prediction: Various Indicators Indicate that the US Economy has Entered a Recession Stage

Over the past year, discussions have been ongoing on whether the US economy will experience a soft landing or recession due to long-term high interest rates. Still, recent claims about an economic recession seem firmly established.

According to the latest report by Affirm in June, nearly 60% of Americans mistakenly believe that the United States is facing an economic recession due to the rising cost of living and increasing economic pressure. According to CME’s “Federal Reserve Watch,” the probability of the Federal Reserve cutting interest rates by 25 basis points in September is 63%, and the probability of cutting interest rates by 50 basis points is 37%.

From a historical perspective, the U.S. economy tends to decline after prosperity, mainly due to the decline in consumption capacity caused by asset foam, debt accumulation, and income inequality. One of the signs of economic recession is the continuous rise in the unemployment rate, especially the disappointing employment data released in early August, which further frightened investors in the US stock market and reminded people of the patterns in past economic recessions.

Source: AICoin

As we mentioned in “With Sudden Plunge, When Will the Market Rebound?“, according to the Sahm Rule proposed by former Federal Reserve economist Sahm, whenever the average of the US unemployment rate in the past three months is higher than the low point of the past 12 months by more than 0.5%, it marks that the US has entered the early stage of economic recession.

Source: NYTimes.com

In fact, since 1950, Sam’s Law has been triggered 11 times, each time indicating afterward that the United States was indeed in the early stages of an economic recession at that time; looking at the present, in June 2024, this rule will be triggered for the 12th time.

In this context, institutions generally expect the Federal Reserve to cut interest rates at least twice, totaling 75 basis points, in the second half of 2024 in response to the economy’s expected loss of momentum.

However, it is worth mentioning that despite the concerns of recession, the US labor market still shows a certain degree of resilience and vitality. For example, the US July CPI announced last night increased by 2.9% year-on-year, lower than the estimated 3%. Traders lowered their expectations for interest rate cuts as inflation data did not become more subdued. From a macro perspective, the existing high interest rates are still attracting global capital to flow to the United States, and the arbitrage trading of the Japanese yen against the US dollar has increased the liquidity of the US dollar in the market. The US economic data still shows a certain degree of strong elasticity.

Review: The Impact of Economic Recession on Financial Markets

The “Black Monday” that global stock markets experienced last week undoubtedly demonstrated the enormous impact of the US economic recession on global financial markets.

The impact of the economic recession on the stock market has been significant and complex in the past decades. The main reasons behind it are diverse, mainly including monetary tightening (the central bank raised interest rates 14 times in total), external shocks (such as war, epidemic, etc., 7 times in total), the reduction of US fiscal spending (5 times), high leverage (high personal or corporate debt, 2 times), and the sharp decline of the stock market itself (for example, the bursting of the Nasdaq foam index in 2000 was accompanied by the September 11 incident, 2 times in total).

History is always astonishingly similar. In the past few decades, economic downturns in the United States have typically been accompanied by stock market corrections or bear markets. During the period of deep recession (more than 3% GDP drawdown, a total of 10 times), the average maximum drawdown of the US S&P 500 index reached -44%, and even in a mild recession (less than 3% GDP drawdown, a total of 8 times), its average maximum drawdown reached -19%, highlighting the enormous pressure faced by the stock market in an economic recession.

Source: SOOCHOW SECURITIES

Of course, the Federal Reserve’s interest rate cut policy has played an important role in responding to economic downturns, but its effectiveness is closely related to the timing. Since 2000, the Federal Reserve has experienced three significant interest rate cut cycles, each accompanied by specific economic backgrounds and stock market performance.

For example, in the period of the bursting of the technology foam in 2000-2003 and the interest rate cut after the September 11 incident, the stock market fluctuated, but the overall correction was significant. A sharp decline in the stock market accompanied the interest rate cut during the 2007-2008 global financial crisis. The interest rate cut in 2019-2020 coincided with the passive release of water against the background of the global spread of COVID-19 to save the economy.

The analysis of the Federal Reserve’s interest rate policy and the performance of the US stock market cannot be summarized in a few words. There are numerous and complex factors to consider, but no matter how analyzed, the negative impact of economic recession on the US stock market is obvious from limited historical data. In the current context where Bitcoin is increasingly linked to the traditional financial world, a series of policy movements by the Federal Reserve will naturally impact it.

Outlook: Bitcoin’s Direction, Looking at Recession or Interest Rate Cuts?

Here, we first present our viewpoint that the market will experience both trading declines and accounting price cuts due to Bitcoin’s speculative and value-storage characteristics.

How should we understand this? The crypto market is susceptible to changes in liquidity. When the expectation of a global economic recession increases or unstable factors intensify, especially in the early stages of this economic shift, investors’ risk appetite will decrease. High-risk assets such as Bitcoin are prone to selling and falling, and even with long-term support such as ETFs, the market will briefly decline to price this panic in real-time. The collapse in March 2020 occurred at a time when COVID-19 was raging and global stock markets were plunging, which is quite similar to the current situation.

Source: glassnode

On the contrary, when the Federal Reserve cuts interest rates and releases water, market liquidity increases, and more funds overflow into high-risk, high-return, and high-vision assets such as Bitcoin, thereby driving its price up.

The bull market in the crypto market from 2020 to 2021 was due to the abundant funds brought about by the unlimited QE at that time, and this bull market also benefited from the influx of traditional funds brought about by the adoption of Bitcoin and Ethereum ETFs.

Looking at the current market situation, BTC’s performance in August and September over the past 14 years has usually been poor, but the fourth quarter often saw excellent performance. Under the expectation of the first interest rate cut starting in September, the market situation may fluctuate and accumulate momentum.

In the long run, although the crypto market has experienced sharp drops such as 312, 94, 519, and the recent 85 drop driven by the economic recession, these drops often quickly release panic and lead to more positive price discoveries as market acceptance increases, infrastructure improves, and investor confidence strengthens.