The rise in interest rates and the emerging scenario

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The Federal Reserve imposed a 75 basis point increase in interest rates, raising its target interest rate range to between 2.25% and 2.5%.

The move confirmed analysts’ expectations, who had predicted that the Fed would raise rates by 75 basis points this month. Less than a week ago, the European Central Bank shocked investors as it raised interest rates for the first time in 11 years, achieving a larger-than-expected 50 basis point rate hike.

Before the last meeting where the Fed made its announcement of the new rate hike, both cryptocurrencies and the stock market saw some relief. The major stock market indices moved higher, including the S&P 500 (1.39%) and the tech-heavy Nasdaq (2.48%), along with the Dow Jones Industrial Average (0.3%).

Bitcoin and Ethereum have risen in the last 24 hours 5.4% and 12.5%, respectively, according to CoinMarketCap. However, both had seen declines over the past seven days and the total value of all cryptocurrencies had temporarily fallen below $1 trillion.

Interest rate hikes around the world

Central banks around the world are raising interest rates to restore price stability and bring runaway inflation under control. In the US, the Fed last month carried out its steepest rate hike since 1994 to combat rising prices, which are rising at their fastest pace in four decades.

The central bank is trying to rein in inflation before it becomes entrenched in the economy. But if the Fed is too aggressive in tightening the economy, it could drive the U.S. into a recession.

Depository institutions, like banks, maintain balances with the Fed, and the interest rate on federal funds determines how expensive it is for them to borrow and lend to each other using those funds. Interest rate increases have ripple effects throughout the financial system, making it more expensive for businesses and consumers to borrow and effectively “cooling” the economy by reducing demand.

Where do institutional investors move in such situations?

As interest rates constrain growth prospects for Wall Street-traded companies, institutional investors are trading stocks and cryptocurrencies for safer investments, such as corporate bonds and U.S. Treasuries, which have less upside than riskier investments but have earnings backed by the federal government. Cryptocurrencies traded in correlation with speculative tech stocks last year, but that identification showed signs of weakening earlier this month.

The cryptocurrency market has been affected by the Fed’s tighter economic policy since it began raising interest rates in March this year.

The history of the rise in inflation

The Fed has a dual mandate: to maintain employment while keeping prices stable, with the goal of keeping inflation around 2% each year. Supply chain disruptions due to coronavirus lockdowns and increased consumer demand fueled by relief programs (three trillion dollars in economic stimulus that increased the total amount of money in circulation) due to the pandemic, among other things, have contributed to the rise in inflation.

When inflation first began to rise last year, the Fed was not quick to raise interest rates because it thought the rise in prices was temporary and would correct itself. More recently, Jerome Powell, the Fed chairman, has been less resolute in his interpretation of inflation:

“Now we understand better how little we understand about inflation,” he said towards the end of June at the European Central Bank (ECB) Central Banking Forum in Sintra, Portugal, adding: “This was unforeseen.”

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