What happened
Shares of stocks in the crypto space struggled today, along with lots of other stocks that took a hit after the Federal Reserve released minutes from its December meeting today.
Shares of the cryptocurrency exchange Coinbase Global (COIN 2.01%) fell more than 6.3% today, while shares of the crypto bank Silvergate Capital (SI -2.44%) fell nearly 10%. Shares of the digital asset wallet company Bakkt Holdings (BKKT 4.97%) fell nearly 18%.
So what
Minutes from the Fed's December meeting sent the market into a free-fall, with the Dow Jones Industrial Average going from being up on the day just before 2 p.m. ET to ending the day down 400 points. The Nasdaq Composite took the minutes even harder, going from being down some in the afternoon to ending the day down 3.34%.
Investors have been heavily adapting their trading strategies since November. That's because the Fed has indicated that it plans to wind down the bond purchases that it began early in the pandemic potentially as soon as March, and then potentially raise its benchmark overnight borrowing rate multiple times this year.
Image source: Getty Images.
The surprise in the Fed's recent meeting minutes came from the fact that members of the Fed are considering decreasing the size of its balance sheet, which is now close to $9 trillion. "Almost all participants agreed that it would likely be appropriate to initiate balance sheet runoff at some point after the first increase in the target range for the federal funds rate," the Fed's minutes stated. The minutes also stated that "the decision to initiate runoff would be data dependent."
Jay Hatfield, CEO of Infrastructure Capital Management, said that balance sheet runoff would be "disastrous," according to CNBC. "I assume that they're going to keep the balance sheet flat, but it is possible if inflation stays really hot that they start letting the balance sheet run off," he said.
When the Fed reduces its balance sheet, that means it's selling assets like Treasuries and mortgage-backed securities back into the market, which effectively removes liquidity. It would be in pretty stark contrast to what the Fed has been doing for nearly two years now, which is injecting liquidity into the system. "You don't want to be in the stock market when the Fed is taking liquidity out of it -- it's like being in Coke when Warren Buffett is selling his position," Hatfield said.
Coinbase, Silvergate Capital, and Bakkt are largely considered tech stocks, even though Silvergate is a licensed bank, but they also trade in correlation to cryptocurrencies to varying degrees. So far, cryptocurrencies have largely reacted to the Fed's recent moves like tech and growth stocks.
Now what
In a rising-rate environment, profitability at Silvergate is actually projected to soar because the bank has billions of excess deposits it could invest in higher-yielding loans and securities. But if the Fed moves to reduce its balance sheet and remove liquidity, that would likely be detrimental to many growth and tech stocks, which have benefited from the excess liquidity.
It's a bit harder to predict how cryptocurrencies will perform in that kind of environment, as some think that certain cryptocurrencies like Bitcoin can hedge inflation. But so far the crypto market has largely reacted negatively to the Fed's recent moves.
