The 2026 Crypto Market Trilemma: The Liquidity Game of Rate Cuts, Rate Hikes, and Elections

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2025 has ended, and the financial markets of this year can be described as a mixed bag of joys and sorrows.

Thanks to the Federal Reserve’s rate cuts and the surge in AI investment enthusiasm, global stock markets achieved nearly the largest annual gain in six years, gold, silver, and platinum repeatedly hit record highs, and traditional assets delivered an impressive performance.

However, the crypto market turned out to be the biggest loser in this feast. Bitcoin’s closing price in 2025 was lower than at the beginning of the year, marking the first time in history that a post-halving year experienced an annual decline. Once regarded as “digital gold,” Bitcoin has fallen behind in this round of major asset rallies.

Disagreements over Bitcoin’s long-term cycle structure continue to widen. Some say the halving narrative has failed, and the four-year cycle has been broken; others believe this is just a temporary adjustment, and the real bull market is still ahead.

As 2026 begins, while wishing everyone a Happy New Year, Rhythm Editor also wants to discuss several important monetary policy and political events in 2026 and explore how they might impact the crypto industry.

Market bets on the Federal Reserve cutting rates 3 times

After the Fed’s last meeting of the year, the published interest rate forecast chart was quite conservative, suggesting that in 2026, there might be only one rate cut, a 25 basis point decrease.

However, most institutions and economists are less pessimistic. Due to political pressure from midterm elections and changes in the Fed’s personnel, they believe the rate cuts in 2026 could exceed market expectations, with 2 to 3 cuts being more appropriate.

Major institutions like Goldman Sachs, Morgan Stanley, and Bank of America are basically betting on 2 cuts, which would bring the rate down from the current 3.50%-3.75% to around 3%-3.25%. Citibank and China Galaxy Securities are more bold, expecting 3 cuts totaling 75 basis points.

Currently, the prediction with the highest probability on Polymarket for the number of rate cuts in 2026 is 2.

Regarding the specific months for rate cuts, there are also many analyses.

For policymakers, low interest rates help stimulate the economy and improve election prospects. Therefore, to demonstrate policy effects before the midterm elections on November 26, 2026, the Federal Reserve needs to significantly cut rates before then. Considering the lag in monetary policy transmission to the real economy, rate cuts should be completed before October 28, 2026. Thus, the December FOMC meeting is too late for election timing.

Most institutions’ predictions for the timing of rate cuts in 2026 are concentrated in the first half of the year.

For example, Nomura Securities predicts June and September; Goldman Sachs expects March and June; Citibank and ABN AMRO Bank forecast January, March, and September.

Currently, the consensus is that the rate cut in June is the most likely, as the new Fed Chair will preside over the FOMC meeting for the first time on June 17-18, 2026. Institutions heavily bet on a rate cut at this meeting, as the new Chair needs to demonstrate loyalty to the White House.

The Fed Reboots “Buy, Buy, Buy”

Beyond rate cuts, another significant action by the Fed in its last meeting of 2025 was the reintroduction of a “Reserve Management Purchase” (RMP) mechanism to buy government bonds again.

Starting December 12, 2025, the New York Fed will purchase approximately $40 billion worth of short-term Treasury bills each month. Officially, this is described as a “technical operation,” not monetary policy, aimed at maintaining “adequate reserves” in the banking system and preparing for the tax season in April next year, when funds will flow from banks to the Treasury.

The Fed’s balance sheet is now about $6.54 trillion. If it continues to buy $40 billion monthly until April next year, it will add roughly $160 billion in assets.

Besides the Fed’s bond purchases, another noteworthy figure is the General Account of the U.S. Treasury (TGA), which can be understood as the government’s checking account at the Fed.

The last government shutdown saw the TGA balance reach a high of $959 billion, with large cash reserves accumulated in the Treasury account.

TGA Balance Changes

It has been over a month and a half since the U.S. government reopened, and the TGA balance is now approximately $850 billion. This means about $100 billion has been released for spending, providing significant liquidity to the market.

For the crypto market, what matters most is whether total liquidity is increasing or decreasing.

Optimistically, the combination of RMP purchases + a significant decline in TGA + some form of tariff dividends at the end of 2026 could give a substantial boost to global liquidity, potentially helping the crypto market to rise.

Why does Japan insist on raising interest rates?

After discussing the Fed, let’s shift our focus to Japan across the Pacific.

The December meeting minutes of the Bank of Japan show that policymakers are discussing the necessity of further rate hikes, with some members calling for “timely” action to control inflation. A Bloomberg survey indicates that economists expect the BOJ to raise rates again in about six months, with most believing the cycle will end at 1.25%. Former BOJ executive Hideo Hayakawa even suggests that by early 2027, rates could rise to 1.50%.

Why is Japan, which is lowering rates globally, still insisting on rate hikes?

This stems from Japan’s unique situation. For decades, Japan has been fighting deflation, with interest rates near zero or even negative. But now, the situation has changed: inflation is rising, wages are starting to increase, and the BOJ finally has the opportunity to “normalize” monetary policy.

The problem is Japan is heavily indebted, with government debt about 200% of GDP. Japanese government bond yields have fallen to levels seen before 2008. With such high debt levels, a rapid increase in interest rates would cause explosive growth in interest payments, potentially overwhelming the bond market.

An even bigger issue is the yen. Before the meeting, the yen had already fallen to its weakest level in 10 months, approaching 160 yen per US dollar. The last time it reached this level, the Japanese government intervened directly in the currency market. Normally, rate hikes should strengthen the currency, but the yen has actually depreciated further.

The core dilemma: Japan’s economy is caught between two difficult choices—either support the bond market or defend the yen; both cannot be achieved simultaneously. The BOJ says it will raise rates to control inflation but also needs to buy large amounts of Japanese government bonds to stabilize the bond market. Rate hikes make the yen more expensive, but at the same time, massive bond purchases flood the market with liquidity—like trying to hit two birds with one stone.

Currently, Japanese government bond yields are at pre-2008 levels, but the yen-dollar exchange rate is near its lowest in 35 years. So, it can be said that the BOJ is “sacrificing the yen to save the bond market.”

The impact of Japan’s rate hikes on the crypto market is directly visible: past hikes in Japan have caused crypto markets to crash. As discussed in previous articles “Why does Japan’s rate hike cause Bitcoin to crash?” and “From Yen rate hikes to mining farm closures, why is Bitcoin still falling?”, the simple reason is that Wall Street and global speculators borrow yen at near-zero costs, convert to dollars, and invest in high-yield assets like Bitcoin and US stocks. It’s like getting free money to speculate—interest-free loans totaling trillions of dollars.

When Japan suddenly raises rates, borrowing costs in yen increase, forcing these institutions to liquidate risk assets, including Bitcoin, to repay yen loans.

Will Japan’s rate hikes in the new year repeat the previous downward trend? Rhythm Editor believes not necessarily, for several reasons:

First, the market has already priced in Japan’s rate hikes. The new year’s hikes are unlikely to be as aggressive, as the market has been discussing this impact for months and has adjusted positions early, unlike last year when it was caught off guard.

Second, as mentioned earlier, the Fed is cutting rates elsewhere. If the Fed indeed cuts 2-3 times in 2026, the interest rate differential between Japan and the US will narrow, reducing the appeal of carry trades. A 0.25% rate hike in Japan might have less impact.

Third, the overall direction of liquidity is more important. As previously discussed, the Fed’s leadership change, RMP bond purchases, TGA releases, and potential tariff dividends could collectively inject liquidity. No one wants to see the economy weaken before the midterm elections more than Trump. If the US continues to loosen monetary policy significantly, Japan’s tightening might be offset.

Of course, short-term volatility is inevitable. If the BOJ suddenly accelerates rate hikes or the Fed’s rate cuts are less aggressive than expected, markets could panic temporarily. But in the medium to long term, the overall trend of global liquidity is the key variable influencing the crypto market.

What if the Democrats win the midterm elections?

Having discussed monetary policies, there’s a more direct factor affecting the crypto industry in 2026: the US midterm elections in November.

Trump and his Treasury Secretary Yellen are well aware that to retain Republican control of Congress, they must deliver tangible economic benefits to voters before the election. That’s why they are pushing for rate cuts and tariff dividends—stimulating the economy to boost their chances.

Currently, the Democrats hold a relatively advantageous position. Recent local elections have boosted their confidence. They won key races such as New York City Mayor, New Jersey Governor, and Virginia Governor, and even made breakthroughs in traditionally red states.

For example, a conservative district in Georgia flipped blue for the first time, despite Trump winning there by 12 points last presidential election. Miami’s mayoral election was won by Democrats for the first time in 30 years. Even in deep red states like Tennessee, Republicans only won by 8%, whereas previously, a victory with over 20% margin was expected. These local election victories are not accidental—they reflect voter dissatisfaction with the current economic situation. If this trend continues into next year, Republicans could lose control of Congress.

Former House Speaker Pelosi recently expressed confidence, predicting Democrats will retake the House in the 2026 midterms. The entire Democratic Party is now optimistic.

On the Republican side, they face many challenges:

Even if the Trump administration begins adjusting tariffs and promoting rate cuts, effects will not be immediate. With the midterm voting in November, and considering policy transmission delays, Trump’s window of opportunity is very tight.

Recently, Trump has been urging Senate Republicans to abolish the “filibuster” rule, allowing senators to delay or block votes through continuous speaking. Trump aims to push his policies quickly and prevent a government shutdown again on January 30. However, many Republicans oppose this, fearing that if Democrats become the majority later, they might adopt similar tactics.

It’s still too early to determine the outcome of the 2026 midterms, with many uncertainties. But some things are certain: to retain their seats, Trump will use all means—rate cuts, fiscal stimulus, tariff dividends—anything that can be done will be done. In the short term, this is positive for risk assets, including cryptocurrencies.

From an investment perspective, Rhythm Editor believes that the first half of 2026 may still offer many opportunities and time windows for action. But as the midterms approach in the second half, uncertainty will rise sharply. If polls favor Democrats, markets may price in this expectation early, and the crypto industry could face correction pressures.