The Fed may pause rates but inject liquidity. Crypto could rally as a recession hedge.

The US Federal Reserve Open Market Committee (FOMC) interest rate decision on May 7 will be a defining moment for risk-on assets, including cryptocurrencies.

The US Federal Reserve Open Market Committee (FOMC) interest rate decision on May 7 will be a crucial factor for risk-on assets, including cryptocurrencies. While economists polled by Dow Jones expect no change in interest rates, any action by the US Treasury to inject liquidity into markets to stave off an economic recession could boost Bitcoin (BTC) and altcoins.

A more accommodative monetary policy could be beneficial for economic activity, but the Federal Reserve (Fed) is also grappling with a weakening US dollar and persistent recession risks, which could create an ideal environment for alternative hedge assets such as cryptocurrencies.

Economist and investor Jim Paulsen points out that when Fed funds trade above a “neutral” interest rate (calculated as Fed Funds minus the annual core Personal Consumption Expenditures Index), the economy has historically moved toward recession or a “growth recession,” characterized by sluggish growth, rising unemployment, and weak consumer demand. Examining periods of above-neutral interest rates since 1971 reveals similar patterns.

According to Paulsen, the Fed will likely be forced to lower interest rates further, and central bank Chair Jerome Powell is facing pressure from US President Donald Trump to reduce the cost of capital more quickly. Trump has criticized the Fed for not cutting interest rates rapidly enough to stimulate the economy.

However, despite the urgency, the Fed is still contending with signals of a strong labor market and consumer spending, which could deter the central bank from pivoting toward rate cuts.

Concerns about overheated markets also remain as the US consumer inflation rate hovers above the 2% target, and April unemployment claims data suggest no signs of economic weakness.

Consumer price index (CPI) inflation edged up to 3.2% year-over-year in April, while the unemployment rate remained at 4.2%.

Market expectations, as indicated by Treasury yield futures, suggest a 76% chance of interest rates at 4.0% or lower by Sept. 17. This probability has decreased significantly from 90% on April 29, according to the CME Group's FedWatch tool.

Bank traders are becoming less confident that the Fed will ease monetary policy. While this may initially seem bearish for risk assets, it could prompt the Treasury to inject liquidity into markets to support government spending.

Regardless of the FOMC's decision, some analysts note that the Fed's recent $20.5 billion Treasury bond purchase on May 5 signals renewed intervention.

Historically, additional liquidity has been bullish for cryptocurrencies, especially as the US dollar lags behind other major global currencies, prompting investors to seek alternative hedges rather than holding cash.

The US Dollar Index (DXY), which measures the greenback against six major rivals, has dropped below the 100 mark for the first time since July 2023 as investors are pulling back from US markets amid economic uncertainty.

On the other hand, gold prices have surged over 12% in the past 30 days and are now trading just 2% below their all-time high of $3,500. This shift in favor of scarce assets may be due to decreasing confidence in the US Treasury's ability to finance its debt.

While the probability of multiple rate cuts has decreased, this scenario would still be advantageous for cryptocurrencies. If the Fed is pressured to expand its balance sheet, it would likely fuel inflation and erode the value of fixed-income investment factors that ultimately provide support for crypto prices.