By James Royal, Ph.D. Brian Baker
Translation: Blockchain in Vernacular
In this article, we will discuss:
The impact of high interest rates and recession fears on the market is gradually fading
Will low interest rates derail the stock market?
How interest rates affect crypto and commodity markets
How should interest rates affect your investment strategy?
Over the past few years, higher interest rates have had an impact on stocks, cryptocurrencies, and commodities like oil. But what can investors expect from it, and how long will the interest rate environment affect the market?
The prospect of higher interest rates has weighed on markets for more than two years, but the path of rates hit a turning point in mid-2023. The Fed has kept rates unchanged for the past 10 meetings, including the one that ended on July 31, a decision that followed its 11th rate hike in this economic cycle. Now, few analysts doubt that rates will soon move lower, as inflation, which hit 3% in June, is gradually coming under control.
1. The impact of high interest rates and recession concerns on the market is gradually weakening
Even though the Fed has raised rates 11 times in this tightening cycle, it was easy to detect when the market really woke up to the central bankâs serious consideration of recalibrating monetary policy. That was in November 2021, when cryptocurrencies and many of the riskiest stocks peaked.
âWhen the Fed introduced tighter monetary policy in 2022 by raising interest rates, this led to a modest depreciation in stock markets and cryptocurrencies,â said Octavio Sandoval, investment director at Illumen Capital.
âThe stock market never stops worrying about future interest rates,â said Steve Azoury, principal at Azoury Financial in Troy, Mich. âBorrowing costs impact every area of ââinvesting, buying and saving. Just the anticipation of what might happen is enough to cause a reaction in the stock market.â
Today, interest rate moves appear to be less frightening for investors as they see the future path of rates is likely to be lower.
While major indices like the S&P 500 have been weak for much of 2022 due to rising interest rates, they have performed well in 2023. The S&P 500 rose about 24% last year, while the Nasdaq Composite rose about 43%. Despite their strong performance in the first half of the year, they have retreated some from their recent all-time highs.
What about the highly anticipated recession? The marketâs recent relative strength suggests investors may be more optimistic than before, or at least less pessimistic than before. Many analysts are predicting a so-called âsoft landing,â where inflation falls and unemployment rises a bit, but the economy doesnât fall into a full-blown recession.
But after strong gains in 2023 and 2024, the market may still have plenty of room to fall if the economy worsens significantly.
Many non-profit high-growth stocks had a difficult 2022, and while prices have stabilized somewhat in 2023, that doesn't mean these stocks are still near their all-time highs. For example, software stocks like Cloudflare, Zoom Video Communications, and Confluent are worth less than half of their all-time highs. Despite the volatility in interest rates, large-cap stocks with strong profitability like Microsoft, Apple, and other companies in the Magnificent 7 have performed well in terms of share prices.
As interest rates looked to be heading higher, cryptocurrency prices suffered, but now that rates look set to fall in the near term, cryptocurrency prices have risen sharply. The launch of a Bitcoin ETF helped drive Bitcoin prices higher, reaching all-time highs in March. The prospect of lower interest rates and inflows into ETFs in the future has also boosted Ethereum prices.
2. Will lowering interest rates derail the stock market?
Stocks and cryptocurrencies have experienced significant volatility as investors factor in rising interest rates. But what will happen over the next six months, with markets pricing in a rate cut from the Fed in September?
Expectations of lower interest rates have helped support rate-sensitive sectors like banks and real estate investment trusts (REITs). Small-cap indexes like the Russell 2000 have performed well in recent weeks as markets begin to price in the possibility of an impending rate cut. Meanwhile, the impending rate cuts donât seem to be boosting big tech companies like Apple, Microsoft and Amazon, whose shares have drifted significantly off their 52-week highs.
Market watchers disagree over whether the Fed will keep interest rates too high for too long and whether that is already priced into current stock prices. That uncertainty itself can drive volatility.
âIâm concerned that by not cutting rates, or cutting rates too soon, we could push the economy into a short-term recession,â said Dan Raju, CEO of brokerage platform Tradier.
âThe soft landing narrative seems to have been established, but there are still many market participants who are skeptical that it will actually happen,â said Brian Spinelli, co-chief investment officer at Halbert Hargrove, a wealth adviser in Long Beach, California.
Meanwhile, markets continue to recalibrate the economic environment around expectations of an imminent fall in interest rates.
Currently, the 10-year Treasury yield is 4.12%, well below the 52-week high of 4.99% reached last October, which has been falling in recent weeks after a rapid rise at the beginning of the year.
Now, with short-term rates well above long-term rates â a so-called inverted yield curve â many market watchers still expect a recession in 2024. A recession would likely cause stocks to fall further until investors can begin to assess the length and depth of any coming downturn. But that wouldnât necessarily prevent stocks from rising occasionally.
3. How interest rates affect the cryptocurrency and commodity markets
The other two major asset classes have reacted differently in the face of higher interest rates. While cryptocurrency prices have plunged along with other risk assets, many commodity prices, including oil, have surged in early 2022, but many of those moves have been short-lived. As the rise in the Federal Reserve's funds rate slowed and paused in 2023, both oil and cryptocurrencies seemed to find some support. Now with the upcoming rate cut, they are both getting an extra boost.
Cryptocurrencies are often touted as a panacea for a variety of problems, whether itâs inflation, low interest rates, lack of purchasing power, a depreciating dollar, etc. As long as cryptocurrency prices rise, these advantages are easy to believe and seem unrelated to other assets.
âThe fact is that cryptocurrency prices have proven to be influenced by the same directional forces that affect retail equity investor sentiment,â Raju said. âIn general, high interest rates scare investors away from risky investments like cryptocurrencies, while lower interest rates will be viewed as a positive by the cryptocurrency investor community.â
In fact, cryptocurrencies and other risky assets responded to reduced liquidity, and when the Federal Reserve announced its intention to raise interest rates in November 2021, they began to fall and continued to fall throughout 2022 as the Fed actively implemented it. In addition, the risks of cryptocurrencies and trading platforms such as FTX caused traders' confidence in these virtual assets to be hit.
But instability in the banking sector has led many traders to bid up cryptocurrencies on the belief that the path of future interest rate increases will be milder.As the 10-year Treasury yield declines after peaking in October in 2023, risk assets have risen as the path of rate cuts becomes clear.
However, other factors have also contributed to the cryptocurrencyâs rise over the past year.
Spinelli pointed to the approval of a spot Bitcoin ETF as a significant factor driving cryptocurrency prices.
In early January, the SEC approved 11 asset managers to offer Bitcoin ETFs. Anticipation of that approval helped cryptocurrencies end 2023 on a strong note, and then inflows into the new ETFs drove cryptocurrencies to all-time highs in March.
Regarding commodities, many have moved away from their recent highs, with some falling slightly due in part to supply constraints and higher interest rates. However, expectations of rate cuts are helping to keep oil from falling significantly below $70 a barrel in 2023 and 2024. In addition, some oil producers have announced supply cuts and provided support to the overall tight market, which has also had an impact on prices.
For example, after reaching a high of about $123 in June 2022, oil prices have been steadily declining to about $70 per barrel. In 2023, oil prices bottomed out around $70 and fluctuated between this price range and $80, although they rose to $90 in the middle of the year. In early December 2023, oil prices recovered to about $70 per barrel to start the new year, but fell again to below $80 in early June 2024 and have continued to fall in recent weeks.
4. How do interest rates affect your investment strategy?
Interest rates, inflation, and uncertainty â it all creates a stew of volatility for investors. Amid so much volatility, investors may want to tread carefully.
For most investors, however, the best way to deal with this market is to stick to a long-term investing plan. For many, a long-term plan means continuing to invest regularly in a diversified portfolio of stocks or bonds, mostly ignoring the noise around the world. For others, the plan might consist of buying and holding a well-diversified index fund. Either way, don't let emotions get in the way of an effective long-term investing plan.
While short-term traders may be anxious about interest rates and trying to time a recession, it is critical to keep things in perspective. Rather than trying to find the right time to sell, buy-and-hold investors can take advantage of market volatility and then try to find the right time to add to their investment.
âFor long-term investors, pullbacks represent attractive buying opportunities,â said Greg McBride, CFA, chief financial analyst at Bankrate.
Market downturns can be attractive times to add to your portfolio at a discount. As investing legend Warren Buffett once said, "In the stock market, you pay a high price for consensus." That is, when few people think stocks are an attractive investment, they are cheaper.
5. Final Conclusion
Interest rates have risen rapidly in 2022 and 2023, and investors now expect the Federal Reserve to cut rates soon. Investors with a long-term investing horizon may view the market downturn as an ideal time to buy some quality investments at a discount.
What if stock valuations plummet? Buffett has some words of wisdom for that situation, too: "Opportunities are rare. When gold starts to rain, catch it with a bucket, not a knuckle."
