In this article
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Higher rates and recession fears losing effect on the market
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Will lower interest rates derail stocks?
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How interest rates have affected crypto and commodities markets
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How should interest rates impact your investing strategy?
Higher rates have been impacting stocks, cryptocurrency, and commodities like oil in recent years. What can investors anticipate from here, and how long will the rate environment affect markets?
For over two years, the possibility of higher interest rates has influenced markets, but the rate trend took a turn in mid-2023. In nine of its last ten meetings, including the one ending on July 31, the Federal Reserve chose to keep rates unchanged after raising them 11 times in this economic cycle. Now, few analysts question that rates are likely to move lower soon as inflation, which reached 3 percent in June, becomes more controlled.
Higher rates and recession fears losing effect on the market
Although the Fed raised rates 11 times during this tightening cycle, it became evident when markets truly paid attention to the central bank’s intention to adjust monetary policy. It was in November 2023 when cryptocurrencies and many high-risk stocks reached their peak.
Octavio Sandoval, director of investments at Illumen Capital, notes, “When the Fed implemented restrictive monetary policies by increasing rates in 2023, equity markets and cryptocurrencies appropriately declined in value.”
Steve Azoury, head of Azoury Financial in Troy, Michigan, mentions, “The stock market is always concerned about future interest rates. The cost of borrowing affects all aspects of investing, purchasing, and saving. The mere anticipation of potential changes can trigger a reaction in the stock market.”
Investors seem less fearful of the direction of rates nowadays, as they anticipate interest rates moving lower in the future.
While major stock indexes like the S&P 500 struggled in 2023 due to rising rates, they performed well in 2023. The S&P 500 saw a growth of about 24 percent last year, while the Nasdaq Composite surged around 43 percent. They continued this positive trend in the first half of this year, although they have retreated slightly from their recent all-time highs.
Regarding the anticipated recession, the recent strength of the market indicates that investors may be more optimistic – or at least less pessimistic – than before. Many analysts predict a potential “soft landing” for the economy, where inflation decreases, unemployment rises slightly, but the economy avoids a full recession.
Despite the strong performance in 2023 and 2024, there could still be room for markets to decline further if the economic conditions significantly deteriorate.
Many unprofitable high-growth stocks faced challenges in 2023, and although prices stabilized in 2023, these stocks are still far from their previous highs. For instance, software stocks like Cloudflare, Zoom Video Communications, and Confluent are valued at less than half of their peak prices. On the other hand, profitable major stocks such as Microsoft, Apple, and others in the Magnificent 7 category performed well despite the rate fluctuations.
Cryptocurrency prices struggled as interest rates were expected to rise, but with the likelihood of lower rates in the near future, crypto prices have seen a significant rise. The introduction of Bitcoin ETFs has also contributed to the surge in Bitcoin prices, reaching an all-time high in March. The expectation of reduced rates and inflows into ETFs have also boosted Ethereum’s value.
Will lower interest rates derail stocks?
Stocks and cryptocurrency experienced notable volatility as investors adjusted to rising rates. However, what lies ahead in the next six months, with the Fed potentially lowering rates as early as September?
The expectation of lower interest rates has benefited rate-sensitive sectors such as banks and real estate investment trusts (REITs). Small-cap indexes like the Russell 2000 have also performed well recently, as the market began pricing in the likelihood of rate cuts. On the other hand, big tech names like Apple, Microsoft, and Amazon have not seen a boost as they have fallen from their 52-week highs.
Market analysts are divided on whether the Fed might keep rates high for too long, which could already be factored into current stock prices. This uncertainty contributes to volatility in the markets.
Dan Raju, CEO of Tradier, expresses concern, stating, “I fear that the reluctance to cut rates, or the fear of cutting rates too early, could lead to a short-term recession.”
Brian Spinelli, co-chief investment officer at Halbert Hargrove in Long Beach, California, notes, “The narrative of a soft landing appears to be gaining traction, but many market participants remain skeptical about its feasibility.”
Meanwhile, markets continue to adjust to the economic landscape in anticipation of lower rates.
The benchmark 10-year Treasury, currently yielding 4.12 percent, is significantly lower than its 52-week high of 4.99 percent reached in October. After an initial surge at the beginning of the year, the yield has been declining in recent weeks.
With short-term rates exceeding long-term rates, creating a yield curve inversion, many market observers still anticipate a recession in 2024. A potential recession could drive stock prices even lower until investors can assess the duration and severity of the downturn. However, intermittent rallies in stock prices may still occur.
How interest rates have affected crypto and commodities markets
Cryptocurrency and commodities have shown diverse responses to rising rates. While cryptocurrency prices plummeted alongside other high-risk assets, certain commodities saw a spike in early 2023, including oil, although these movements were short-lived. With the slowdown in the rising Fed funds rate and its subsequent pause in 2023, both oil and crypto seem to have found some stability. The anticipation of lower rates has provided additional support to these markets.
Cryptocurrency has often been viewed as a hedge against inflation, low interest rates, currency devaluation, and other economic challenges. However, the positive outlook on crypto was contingent on its upward trajectory, seemingly independent of other asset classes.
Dan Raju comments, “Crypto prices have been influenced by the same sentiment that affects retail stock investors. In general, high interest rates deter investors from riskier assets like crypto, and the prospect of lower rates is seen as positive by the crypto investor community.”
Cryptocurrencies reacted to reduced liquidity, similar to other high-risk assets, by declining when the Fed announced its rate hike intentions in November 2023 and throughout 2023 as the Fed followed through with aggressive rate increases. Additionally, issues within the cryptocurrency sector, such as the collapse of cryptocurrencies and exchanges like FTX, eroded traders’ confidence in these digital assets.
However, instability in the banking sector encouraged traders to invest in cryptocurrency, anticipating milder future rate hikes. As 10-year Treasury rates peaked in October 2023 and subsequently declined, riskier assets experienced a resurgence as the path to lower interest rates became clearer.
Other factors have also influenced the rise of cryptocurrency in recent times.
Brian Spinelli highlights the approval of spot Bitcoin ETFs as a significant driver of crypto prices.
In early January, the SEC approved 11 asset managers to offer Bitcoin ETFs. The anticipation of this approval bolstered cryptocurrency performance in 2023, and the influx into these new ETFs propelled Bitcoin to a new all-time high in March.
Regarding commodities, many have retreated from their recent highs due to reduced supply constraints and higher interest rates. However, the expectation of lower rates has prevented a significant decline in oil prices, which hovered around $70 per barrel in 2023 and 2024. Factors such as supply cuts by petroleum-producing nations and overall market tightness have supported pricing.
For instance, the price of oil declined steadily to around $70 per barrel after peaking at approximately $123 in June 2023. Throughout 2023, oil fluctuated between $70 and $80, with a temporary rise to $90 mid-year. Following a dip to around $70 per barrel in early December 2023, oil prices trended upwards at the start of the year but retreated below $80 in early June and have since decreased.
How should interest rates impact your investing strategy?
Interest rates, inflation, and uncertainty contribute to market volatility, prompting caution among investors. In such turbulent times, it is advisable for investors to stick to their long-term investment plans.
For most investors, maintaining a diversified portfolio of stocks or bonds and adhering to a long-term investing strategy is key. This approach involves regular investments and disregarding short-term market fluctuations. Alternatively, some investors opt for well-diversified index funds for a more passive investment strategy. Regardless, emotions should not dictate investment decisions, especially during periods of volatility.
While short-term traders may be concerned about rates and recession timing, it is crucial to maintain perspective. Instead of trying to time the market, long-term investors can leverage market volatility to their advantage and seize opportunities to enhance their portfolios.
Greg McBride, CFA, Chief Financial Analyst at Bankrate, suggests, “Market downturns present attractive buying opportunities for long-term investors.”
During market downturns, adding to your portfolio at discounted prices can be advantageous. As Warren Buffett famously said, “You pay a very high price in the stock market for a cheery consensus.” In essence, stocks are more affordable when they are not considered attractive by the majority of investors.
Bottom line
After a period of rapid interest rate increases, investors are now anticipating a shift towards lower rates by the Fed. For long-term investors, market downturns may present opportunities to acquire quality investments at discounted prices.
If stock valuations experience a significant decline, Warren Buffett’s advice rings true: “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.