Authored by: James Royal, Ph.D. Brian Baker
In this article, we will discuss:
Gradually diminishing impact of high interest rates and economic recession concerns on the market
Will low interest rates derail the stock market?
How do interest rates affect the cryptocurrency and commodity markets?
How should interest rates affect your investment strategy?
In recent years, high interest rates have had an impact on stocks, cryptocurrencies, and commodities such as oil. But what can investors expect from this, and how long will the interest rate environment affect the market?
For over two years, the prospect of high interest rates has been influencing the market, but there has been a turning point in the interest rate trend in mid-2023. In the past 10 meetings, including the one that ended on July 31st, the Fed chose to keep interest rates unchanged, the 11th decision to hold rates after 11 rate hikes in this economic cycle. Now, few analysts doubt that interest rates will soon be lowered, as inflation reached 3% in June and has gradually been brought under control.
1. Gradually diminishing impact of high interest rates and economic recession concerns on the market
Although the Fed has raised interest rates 11 times in this tightening cycle, it was easy to notice when the market truly became alert to the central bank seriously considering readjusting monetary policy. That was in November 2021 when cryptocurrencies and many of the riskiest stocks reached their peak.
Octavio Sandoval, Director of Investments at Illumen Capital, said, “When the Fed introduced a tightening monetary policy through rate hikes in 2022, it led to appropriate devaluation of the stock market and cryptocurrencies.”
“The stock market will never not worry about future interest rates,” said Steve Azoury, head of Azoury Financial in Troy, Michigan. “The cost of borrowing affects various areas of investment, purchase, and savings. Just the anticipation of what might happen is enough to cause a reaction in the stock market.”
Now, the trend of interest rates seems to no longer cause panic among investors, as they see a possible path of lower interest rates in the future.
Although major stock indices like the S&P 500 Index performed weakly in 2022 due to rising interest rates, they have performed well in 2023. The S&P 500 Index rose by about 24% last year, while the Nasdaq Composite Index rose by about 43%. Despite their strong performance in the first half of this year, they have retraced somewhat from their recent historic highs.
So, what about the highly anticipated recession? The recent relative strength of the market suggests that investors may be more optimistic than before, or at least less pessimistic. Many analysts predict that the economy may experience a so-called “soft landing,” with inflation declining, unemployment rising, but without the economy falling into a complete recession.
However, after strong gains in 2023 and 2024, if the economy significantly deteriorates, there may still be significant downside potential for the market.
Many high-growth stocks without profits experienced difficulties in 2022, and although prices stabilized in 2023, it does not mean that these stocks are now close to their historic highs. For example, software stocks like Cloudflare, Zoom Video Communications, and Confluent are valued at less than half their historical highs. Despite interest rate fluctuations, profitable large-cap stocks like Microsoft, Apple, and other companies in the Magnificent 7 have performed well in terms of stock prices.
As interest rates appeared to rise, cryptocurrency prices were affected, but now with interest rates seeming to drop in the short term, cryptocurrency prices have surged. The launch of Bitcoin ETFs has helped drive up the price of Bitcoin, reaching an all-time high in March. The prospects of future interest rate cuts and inflows into ETFs have also boosted the price of Ethereum.
2. Will lowering interest rates derail the stock market?
Stocks and cryptocurrencies have experienced significant fluctuations as investors consider rising interest rates. But what will happen in the next six months as the market expects the Fed to cut rates in September?
The expected rate cut has already helped support interest rate-sensitive industries such as banks and Real Estate Investment Trusts (REITs). Small-cap indices like the Russell 2000 Index have performed well in recent weeks as the market begins to price in the possibility of an imminent rate cut. However, the upcoming rate cut does not seem to have boosted large tech companies like Apple, Microsoft, and Amazon, whose stock prices have deviated significantly from their 52-week highs.
Market observers have different opinions on whether the Fed will keep rates too high for too long and whether this is already reflected in current stock prices. This uncertainty itself will drive market volatility.
“I am concerned that not cutting rates or cutting rates too early could push the economy into a short-term recession,” said Dan Raju, CEO of brokerage platform Tradier.
“The narrative of a soft landing seems to be established, but many market participants are skeptical that this will actually happen,” said Brian Spinelli, Co-Chief Investment Officer at Halbert Hargrove in Long Beach, California.
Meanwhile, the market continues to adjust to the expected decline in interest rates.
Currently, the yield on 10-year Treasury bonds is 4.12%, well below the 52-week high of 4.99% set in October last year. This has been declining in recent weeks after a rapid rise earlier in the year.
Short-term rates are now significantly higher than long-term rates – the so-called inverted yield curve – and many market observers still expect a recession to occur in 2024. A recession could further push the stock market down until investors can begin to assess the duration and depth of any upcoming recession. However, this may not prevent occasional upticks in the stock market.
3. How do interest rates affect the cryptocurrency and commodity markets?
Two other major asset classes have reacted differently to higher interest rates. While cryptocurrency prices plummeted along with other risky assets, many commodity prices, including oil, soared in early 2022, but many of these movements were short-lived. With the Fed’s rate hike slowing down and pausing in 2023, both oil and cryptocurrencies seem to have found some support. Now, with the upcoming rate cut, they are both receiving additional boosts.
Cryptocurrencies are often touted as a panacea for various issues, be it inflation, low interest rates, purchasing power, dollar depreciation, and more. As long as cryptocurrency prices rise, these advantages easily make it seem unrelated to other assets.
“The fact is, cryptocurrency prices have been proven to be influenced in the same directional manner by the sentiment of retail stock investors,” said Raju. “Overall, high interest rates scare investors away from risk investments like cryptocurrencies, while a rate cut will be seen as a positive factor by the cryptocurrency investor community.”
Indeed, cryptocurrencies and other risky assets responded to reduced liquidity when the Fed announced its intention to raise rates in November 2021, they started to decline and continued to fall throughout 2022 as the Fed actively implemented rate hikes. Additionally, the risks associated with cryptocurrencies and trading platforms like FTX have shaken traders’ confidence in these virtual assets.
However, banking instability has led many traders to raise their cryptocurrency holdings as they believe the future path of interest rate growth will be more moderate. With the 10-year Treasury bond yield peaking in October 2023 after a decline, risky assets rose as the path of rate cuts became clearer.
Nevertheless, the rise in cryptocurrencies over the past year has also been influenced by other factors.
Spinelli pointed out that the approval of physically-backed Bitcoin ETFs was a significant factor driving cryptocurrency prices.
In early January, the SEC approved 11 asset management companies to offer Bitcoin ETFs. The expected approval helped cryptocurrencies end 2023 on a strong note, and then the influx of funds into the new ETFs pushed cryptocurrencies to new all-time highs in March.
Regarding commodities, many have moved away from their recent highs, partly due to restricted supply and slightly higher interest rates causing them to dip. However, the expectation of rate cuts has helped keep oil prices from plummeting below $70 per barrel in 2023 and 2024. Additionally, some oil-producing countries have announced supply cuts, supporting the overall tightness in the market and impacting prices.
For example, after reaching a high of around $123 in June 2022, oil prices steadily declined to about $70 per barrel. By 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 rebounded to around $70 per barrel to start the new year, but by early June 2024, they fell below $80 and have continued to decline in recent weeks.
4. How do interest rates affect your investment strategy?
Interest rates, inflation, and uncertainty – all these create a potpourri of volatility for investors. In such a volatile environment, investors may want to proceed with caution.
However, for most investors, the best way to deal with this market is to stick to a long-term investment plan. For many, a long-term plan means continuing to invest regularly in a diversified portfolio of stocks or bonds, mostly ignoring the noise from around the world. For others, the plan may include buying and holding well-diversified index funds. Whichever way, do not let emotions hinder an effective long-term investment plan.
While short-term traders may be anxious about interest rates and trying to time the onset of a recession, maintaining perspective is crucial. Rather than trying to find the right time to sell, buy-and-hold investors can take advantage of market volatility to profit and then try to find the right time to add to their investments.
“For long-term investors, pullbacks represent attractive buying opportunities,” said Greg McBride, CFA, Chief Financial Analyst at Bankrate.
5. Conclusion
Interest rates rose rapidly in 2022 and 2023, and investors now expect the Fed to cut rates soon. Investors with a long-term investment outlook may see market declines as an ideal time to purchase quality investments at a discount.
What if stock valuations plummet? For such a scenario, Warren Buffett has some wise words: “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” In other words, when few people see stocks as an attractive investment, they are cheaper.
