Fed Rate Cut Hopes Run Into Inflationary Red Sea Crisis

No sooner did the U.S. Federal Reserve (Fed) signal on Dec. 13 that it expects to cut interest rates three times in 2024, traders priced in the first dovish move for March, bolstering the bullish mood in both crypto and traditional markets.

However, five weeks later, the probability of the Fed delaying the first rate cut beyond March appears high, thanks to disruptions to commercial shipping traffic via the Red Sea/Suez Canal route and resulting inflation fears.

"The next FOMC meeting on 31st January will be a difficult platform for the Fed to communicate any change in stance ahead of March if elevated geopolitical risks in the Red Sea region are raising concerns over supply disruption and energy prices feeding into higher inflation," analysts at ING said in a note to clients early this month.

That's an unwelcome development for bitcoin bulls hoping the Fed would lay the groundwork for rapid fire rate cuts at its meeting next week, helping stall the recent price drop caused by GBTC outflows and FTX sales. The Fed's benchmark interest rate currently stands between 5.25% to 5.5%, having raised the borrowing cost by 525 basis points between March 2022 and July 2023. The rapid tightening partially caused the 2022 bitcoin bear market.

Recent attacks by Iranian-backed Houthis from Yemen on commercial vessels in the Red Sea have led to a sharp decline in the number of vessels passing through the Suez Canal, a vital passage for global trade, including 20% of the world's oil and 25% of global liquified natural gas, and the equally important Panama Canal. According to ING, shipowners are increasingly choosing the longer and more expensive route via Southern Africa.

That has raised concerns about supply disruptions and higher energy prices, which could translate into higher inflation, as seen following the coronavirus-induced global lockdown of 2020. Central banks, including the Fed, would have scant leeway to cut rates if inflation rebounds at a time when wage growth remains sticky.

"This rerouting affects 20% to 30% of all shipping globally and adds considerable time and expense. For an inflation statistician, anything that travels by ship will get more expensive, all else being equal. Given that inflation operates at a considerable lag, if this situation persists, the effects will only appear many months from now," Arthur Hayes, the chief investment officer of family office Maelstrom and the ex-CEO of BitMEX, said in a blog post, explaining the potential for bitcoin to fall below $35,000 in the near-term.

"While the markets are cheering YoY inflation statistics falling in the U.S. and elsewhere, it might be a pyrrhic victory," Hayes added.