Yesterday, the Federal Reserve announced that they would be raising interest rates by a further 75 basis points. In all markets, yesterday was an extremely volatile day, since the Federal Reserve has such a large impact on the “free market” that whatever they announce is to be extremely important.
Inflation fears abound, and there has been some pressure on the Federal Reserve to raise interest rates to get the dollar under control. On the other hand, there have also been concerns that raising interest rates too much higher could spell doom for an economy that is already struggling to grow.
The Federal Reserve is unpredictable
Traders often enjoy high degrees of volatility, especially when they are taking out leverage in short-term positions. Yesterday was a day that many traders were able to enjoy – if they were on the right side of the markets.
The main cause for such volatility is the fact that the Federal Reserve is extremely unpredictable. Unlike with Bitcoin, where the hash rate is known, the block time is known, the inflation rate is known ad infinitum and the difficulty adjustment changes every two weeks, there is no way to reasonably audit the thoughts inside Jerome Powell’s head.
It seems an undesirable job, especially if one agrees with the economist David Murrin, who argues that the US is now entering the final few stages of its empire cycle and doesn’t have the strength in its economy to outgrow the mountain of debt that it has accumulated. This, alongside the fact that China is developing as a rising power and potential challenger, means that the 2020s could well be one of the worst possible decades to preside over the sinking ship that is the US economy.
Unpredictability drives volatility, and there had been speculation from analysts such as Raoul Pal, who had previously stated that he didn’t believe there would even be another hike in interest rates, since there would be no way that the economy could recover were they to be raised again.
A lot of people try to trade based on what the Federal Reserve will announce
It is now easier than ever to trade, and the rising in the financial industry has meant that it isn’t just industry professionals who are speculating on the markets, but also retail investors.
— Salchipapero (@Salchipapero99) September 21, 2022
Unlike traditional markets, trading in the crypto markets is 24/7, meaning that it is easier than ever for people to speculate on what the Federal Reserve says.
It does make sense for traders to take note of what the Federal Reserve says, since not only does proximity to the money printer shape society, but also because the Federal Reserve now owns a huge part of the economy and plans to unwind its balance sheet have thus far proved futile.
Speculation over the impact of rate rises
In addition to wondering about what the Federal Reserve might announce, there are also those who speculate on what their announcement will mean in the medium to long term, and what some of the secondary and tertiary effects may be.
For example, some have speculated that raising interest rates are the responsible thing to do in order to stop completely unsustainable rises in inflation, whereas others believe that raising interests will ultimately be a bad thing, since the markets across the board will collapse.
Short squeezes are common
Volatility can often lead to more volatility, as emotions run high during periods of high gains and losses. In events such as this, people are often keen to take out leverage to add to their positions.
Leverage can create a lot more volatility and goes hand in hand with short selling. Traders who are liquidated (either because they took out a leveraged long or a short) are eventually forced to close their positions when they are liquidated by pushing price in the other direction.
This phenomenon can often be quite visible on order book-based exchanges, and in DeFi it is easy to know how much is going to be liquidated and at what prices.
Markets can often be irrational, and moments of uncertainty (which is what the Federal Reserve creates in spades) are moments when volatility can be extremely high, and market moves extremely unpredictable. There are some market participants who will try to intentionally liquidate others by using leverage, and when this caused a series of cascading liquidations, volatility can rise even further.
For those who are interested in trading such events, it is important to be considerate of using stop losses and adequate portfolio management.
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