Monetary Policy and Financial Markets: A Causal Analysis of the Fed's Interest Rate Effect on the U.S. Stock Market and Major Cryptocurrencies

Madhan Gopal Perumal, Ragavanantham Shanmugam

Abstract: This study investigates the causal relationship between the Federal Reserve's interest rate policy and financial markets, with emphasis on asset-specific responses across major U.S. stock indices and leading cryptocurrencies. The Fed's interest rate decisions significantly influence various economic facets, including the stock market's behavior, making it crucial to understand these liaisons for investors, banks, and policymakers. This study contrasts the reactions of the Nasdaq, DOW, and S&P500 indices with those of Bitcoin and Ethereum, while controlling for inflation, long-term interest rates, supply chain disruptions, and energy prices to provide a thorough analysis. The intervention centres around the Fed's rate cuts prompted by the COVID-19 pandemic, a period marked by unprecedented economic turmoil. The study aspires to offer insights into monetary policy's role and value. Findings reveal distinct heterogeneity in market reactions: while the Nasdaq index experienced robust and sustained positive effects following the policy intervention, the DOW exhibited significant adverse impacts and the SP500 responded in more nuanced fashion. Cryptocurrencies display comparatively weaker and less consistent responses, indicating reduced sensitivity to conventional monetary policy transmission. The findings aim to shed light on how Fed interest rate adjustments can drive financial institutional policies. This study's results indicate that the Federal Reserve's rate cut initiated during the COVID-19 pandemic illuminates the complex transmission mechanisms of monetary policy, and that there is a differential effect of interest rates on crypto vs. stock markets. This study aims to enhance understanding of market dynamics in response to monetary interventions, providing valuable insights for investors, financial institutions, and policymakers navigating periods of crisis.

Keywords: Stock Market, Cryptocurrency, Bitcoin, Monetary Policy, Financial Markets, COVID-19, Nasdaq