For years, analysts and traders have said cooling inflation would benefit the crypto market, yet prices are still down. Cointelegraph explains why.

Investors’ risk appetite tends to increase with a lower cost of capital and higher liquidity, creating a favorable scenario for high-growth assets. Consequently, Bitcoin and other cryptocurrencies often benefit from such conditions, as more money in circulation typically boosts demand. However, if United States inflation appears to be under control, why isn’t the cryptocurrency market reacting positively?

Interest rate cuts impact corporate earnings and real estate markets

The United States Federal Reserve closely monitors the job market, inflation and the value of the dollar to adjust its policies accordingly. When inflation trends near the Fed’s 2% target, it allows room for reducing interest rates and injecting liquidity by providing banks with the necessary capital, especially when the economy shows signs of weakness. This movement, known as expansionary, reduces incentives for fixed-income investments.

The most recent figures from the Federal Reserve’s preferred inflation indicator revealed a deceleration in inflation for May. During this period, price increases registered their slowest growth since March 2021, marking the initial occurrence within this economic cycle that inflation surpassed the Fed’s 2% target. The core Personal Consumption Expenditures (PCE) index, excluding food and energy costs, rose by 2.6% year-over-year in May, aligning with the predictions of economists.

San Francisco Fed President Mary Daly commented to CNBC’s Andrew Ross Sorkin in an interview, “It is just additional news that monetary policy is working, inflation is gradually cooling.” Additionally, the U.S. Bureau of Economic Analysis reported that personal income increased by 0.5% monthly, surpassing the anticipated 0.4%. On the other hand, consumer spending rose by 0.2%, slightly below the expected 0.3%.

Earlier in the year, market traders had anticipated at least three interest rate reductions; however, current projections have adjusted to only two, anticipated to commence in September. Seema Shah, the chief global strategist at Principal Asset Management, told CNBC that “a further deceleration in inflation, ideally coupled with additional evidence of labor market softening, will be necessary to pave the way for a first rate cut in September.”

The most recent U.S. inflation data, along with a 4% unemployment rate and personal income growth, led the S&P 500 to reach an all-time high on June 28. Yet, the total cryptocurrency market capitalization is down from its 2024 peak on March 14. Even gold, typically considered a hedge asset, is currently trading merely 5% below its all-time high from May 20.

Related: Bitcoin activity drops to lowest level since 2010

Cryptocurrencies tend to underperform when the U.S. dollar displays strength

Theoretically, cryptocurrencies should benefit from the prospect of interest rate cuts and other expansionary measures due to their scarcity and non-censurable payment methods. However, the relative success of the Fed’s strategy strengthens the U.S. dollar, which can be measured against a basket of foreign exchange rates using the U.S. Dollar Index (DXY). A higher DXY means that the euro, pound and Swiss franc are losing value.

Currently, the DXY is flirting with 106, its highest level since November 2023, and the U.S. five-year Treasury yield has decreased to 4.30% from 4.72% on April 25. This indicates that investors are relatively confident in a “soft landing,” where inflation decreases without an economic recession. In this case, traders likely expect the stock market to continue reaching new highs without significant shock in the real estate market.

This hypothesis explains why lower inflation has not positively impacted the cryptocurrency market. However, there is still uncertainty about how the economy and the U.S. dollar will behave if the Fed opts for an expansionary monetary policy. Therefore, a rally for Bitcoin and cryptocurrencies later in 2024 should not be ruled out.