How the Fed impacts stocks, crypto and other investments

Stocks, cryptocurrencies, and commodities like oil have been experiencing higher rates over the past few years. So what can investors expect next and how much will the rate environment impact the markets?

The prospect of higher interest rates has been weighing on markets for more than two years, but the direction of rates has reached a turning point in mid-2023. At nine of its last 10 meetings, including the one that ended July 31, the Federal Reserve has chosen to hold rates steady after raising them 11 times this economic cycle. Now, several analysts are skeptical that rates will fall soon as inflation, which reached 3% in June, is increasingly under control.

High interest rates and recession fears are losing their grip on the market

Even though the Fed has raised interest rates 11 times during this tightening cycle, it’s easy to spot when markets really stand up and realize the central bank is about to recalibrate monetary policy. Crypto and many of the riskiest stocks peaked in November 2021.

“When the Fed introduced restrictive monetary policies by raising interest rates in 2022, this caused a corresponding decline in the valuation of equity markets and cryptocurrencies,” says Octavio Sandoval, investment director at Illumen Capital.

“The stock market will never worry about future interest rates,” says Steve Azoury, president of Azoury Financial in Troy, Mich. “The cost of borrowing affects all areas of investing, purchasing and saving. Just the anticipation of what’s going to happen is enough to cause a stock market reaction.”

And the direction of interest rates now appears to scare investors less, as they predict that the future trajectory of interest rates is likely to be more downward.

Major stock indexes like the Standard & Poor’s 500 are likely to perform well in 2023, even though they spent most of 2022 in a slump due to rising rates. The S&P 500 is up about 24% last year, while the Nasdaq Composite is up about 43%. That followed a strong first half this year, but they’re down slightly from recent all-time highs.

What about the much-anticipated recession? The market’s recent relative strength suggests investors may be more optimistic—or at least less pessimistic—than they have been. Many analysts are predicting a so-called “soft landing” for the economy, a scenario in which inflation falls and unemployment rises slightly but the economy doesn’t enter a full-blown recession.

But after a strong rally in 2023 and 2024, there may still be room for markets to decline further if the economy deteriorates significantly.

The story continues

Many unprofitable high-growth stocks have struggled in 2022, and while prices have firmed up in 2023, that doesn’t mean they’re still near their previous highs. For example, software stocks like Cloudflare, Zoom Video Communications, and Confluent are worth less than half of their all-time highs. Still, profitable big-name stocks like Microsoft, Apple, and others in the Magnificent 7 have performed well despite the rate moves.

Cryptocurrency prices struggled as interest rates began to rise, but now that rates appear poised to fall in the near term, crypto prices have risen significantly. And the launch of Bitcoin ETFs has helped boost the price of Bitcoin, which reached an all-time high in March. Lower rates and the potential for entry into ETFs have also pushed Ethereum higher.

Will falling interest rates derail stocks?

Stocks and cryptocurrencies have been subject to significant volatility as investors factor in rising rates. So what’s in store for us in the next six months, with the Fed expected to cut rates in September?

The prospect of lower interest rates has helped boost interest rate-sensitive sectors like banks and real estate investment trusts (REITs). Small-cap indexes like the Russell 2000 have also performed well in recent weeks as the market has begun to price in the possibility that interest rate cuts are imminent. At the same time, the imminent arrival of lower interest rates does not appear to have helped big tech companies like Apple, Microsoft and Amazon, which have fallen significantly from their 52-week highs.

Market watchers are still divided on whether the Fed will keep interest rates too high for too long and whether that is already reflected in current stock prices. That uncertainty is fueling volatility in markets.

“I fear that the fear of not cutting rates or cutting rates too early could push the economy into a short-term recession,” says Dan Raju, CEO of brokerage platform Tradier.

“The soft landing narrative seems to be catching on, but there are many market participants who are skeptical that it will actually happen,” said Brian Spinelli, co-chief investment officer at asset advisory firm Halbert Hargrove in Long Beach, California.

Meanwhile, markets continue to readjust to the economic environment with expectations that interest rates will fall further.

The benchmark 10-year Treasury note, currently yielding 4.12 percent, is well below the 52-week high of 4.99 percent set in October after a rally earlier in the year and has been falling in recent weeks.

Now, with short-term interest rates far above long-term interest rates — the so-called yield curve inversion — many market watchers still expect a recession in 2024. The recession will likely push the stock market lower until investors begin to gauge the length and depth of any impending decline. But that may not stop stocks from rallying intermittently.

How did interest rates affect the crypto and commodity markets?

The other two major asset classes have reacted differently to higher rates. While cryptocurrency prices fell along with other riskier assets, many commodities, including oil, rose in early 2022, but most of those moves were short-lived. With the rising Fed funds rate slowing and then pausing in 2023, both oil and crypto appear to have found some support. And now, with lower rates on the horizon, both have found an additional tailwind.

Cryptocurrency has often been touted as a cure for everything that ails you, whether it’s inflation, low interest rates, lack of purchasing power, devaluation of the dollar, etc. As long as the cryptocurrency is going up, regardless of other assets, it’s easy to believe in these positive things.

“The reality is that crypto prices have been proven to be affected by the same sentiment that affects retail stock investors,” Raju says. “Generally, higher interest rates tend to push investors away from riskier investments like crypto, and lowering rates will be viewed positively by the crypto investor community.”

Indeed, cryptocurrencies, like other risky assets, responded to diminishing liquidity with declines throughout 2022, as the Fed announced its intention to raise interest rates in November 2021 and then aggressively followed up. On top of that, the explosion of cryptocurrencies and exchanges like FTX has shaken investors’ confidence in these virtual assets.

But instability in the banking sector has led many investors to boost cryptocurrency holdings, believing the future path of interest rate hikes will be less steep. And when 10-year Treasury rates peaked in October 2023 and then fell, riskier assets rose as the path to lower interest rates appeared clear.

However, other factors also play a role in the rise of cryptocurrencies in the last year.

Spinelli points to the approval of spot Bitcoin ETFs as a key driver of crypto prices.

In early January, the SEC approved 11 asset managers to offer Bitcoin ETFs. Anticipation of the approval helped the cryptocurrency finish 2023 strong, and subsequent inflows into new ETFs helped the cryptocurrency reach a new all-time high in March.

As for commodities, many are well off their recent highs as fewer supply constraints and higher interest rates try to pull them down a few notches. But the prospect of lower rates has helped keep oil from falling significantly below $70 a barrel in 2023 and 2024. Pricing has also been supported by oil-producing countries announcing supply cuts and general market tightness.

For example, the price of oil has been on a steady downtrend to around $70 per barrel after reaching around $123 in June 2022. And in 2023, oil bottomed out around $70 and fluctuated between that level and $80, although it rose to $90 by mid-year. After reaching around $70 per barrel in early December 2023, oil trended higher at the beginning of the year, but fell back below $80 in early June and has been falling in recent weeks.

How should interest rates affect your investment strategy?

Interest rates, inflation, and uncertainty all create a stew of volatility for investors. With so much volatility, investors may want to proceed with caution.

However, the best way for most investors to approach this type of market is to stick to a long-term game plan. For many, that long-term plan means staying invested in a well-diversified portfolio of stocks or bonds and mostly ignoring the noise in the world. For others, the game plan might involve buying and holding well-diversified index funds. Either way, don’t let emotions get in the way of an effective long-term investment plan.

While short-term investors may be pushing rates and trying to time a recession, it’s vital to keep things in perspective. Instead of trying to find the right time to sell, buy-and-hold investors can use the market’s volatility to their advantage and then try to find the right time to add more.

“For long-term investors, pullbacks present attractive buying opportunities,” says Greg McBride, CFA, chief financial analyst at Bankrate.

Downturns can be a tempting time to add to your portfolio at discounted prices. As investing legend Warren Buffett once said, “In the stock market, you pay a high price for a cheerful consensus.” That is, stocks are cheaper when few people agree that they are an attractive investment.

In conclusion

Interest rates have risen rapidly in 2022 and 2023, and investors now expect the Fed to cut interest rates soon. Investors with a long-term investment horizon may see the decline as an ideal time to pick up quality investments at affordable prices.

But what if stock valuations fall? Buffett has some wisdom for that, too: “Opportunities come rarely. When it rains gold, get out the bucket, not the thimble.”

Editorial Disclaimer: All investors are advised to conduct their own independent research on investment strategies before making any investment decision. Investors are also advised that past investment product performance is no guarantee of future price appreciation.