How does the Federal Reserve influence stocks, cryptocurrencies, and other investments?
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How does the Federal Reserve influence stocks, cryptocurrencies, and other investments?
Interest rate changes have a significant impact on the market; investors should maintain a long-term perspective amid volatility and look for discounted investment opportunities.
Navigating Web3 tides with focused insightsBy: James Royal, Ph.D. Brian Baker
Translation: Baihua Blockchain
In this article, we will discuss:
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The fading impact of high interest rates and recession concerns on markets
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Could lower interest rates send stock markets off track?
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How interest rates affect cryptocurrency and commodity markets
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How should interest rates influence your investment strategy?
Over the past few years, high interest rates have influenced stocks, cryptocurrencies, and commodities such as oil. But what can investors expect, and how long will the rate environment continue to affect markets?
For over two years, the prospect of higher interest rates has weighed on markets. However, a turning point emerged in mid-2023. In its last 10 meetings—including the one ending July 31—the Federal Reserve chose to hold rates steady, following 11 rate hikes during this economic cycle. Now, few analysts doubt that rates will soon decline, as inflation reached 3% in June and continues to moderate.
1. The fading impact of high rates and recession fears on markets
Although the Fed raised rates 11 times during this tightening cycle, the market's real alertness to the central bank’s serious consideration of adjusting monetary policy was clearly visible. That moment came in November 2021, when cryptocurrencies and many of the riskiest stocks peaked.
"When the Fed introduced tight monetary policy through rate hikes in 2022, it led to an appropriate devaluation in both stock and cryptocurrency markets," said Octavio Sandoval, Chief Investment Officer at Illumen Capital.
"Stock markets are never immune to concerns about future interest rates," said Steve Azoury, head of Azoury Financial in Troy, Michigan. "Borrowing costs affect every area of investment, spending, and saving. Just the anticipation of what might happen is enough to trigger reactions in the stock market."
Today, however, the direction of interest rates no longer seems to alarm investors as much, as they see a potential downward path ahead.
While major indices like the S&P 500 performed weakly for much of 2022 due to rising rates, they rebounded strongly in 2023. Last year, the S&P 500 rose about 24%, while the Nasdaq Composite gained roughly 43%. Despite strong performance in the first half of this year, both indexes have pulled back somewhat from recent all-time highs.
What about the widely anticipated recession? The market’s relative strength recently suggests investors may be more optimistic now—or at least less pessimistic than before. Many analysts now predict a so-called "soft landing," where inflation declines, unemployment rises slightly, but the economy avoids a full-blown recession.
Still, after strong gains in 2023 and 2024, markets could still fall significantly if the economy deteriorates sharply.
Many unprofitable, high-growth stocks struggled in 2022. Although prices stabilized in 2023, these stocks are still far from their historical peaks. For example, software stocks like Cloudflare, Zoom Video Communications, and Confluent are worth less than half of their all-time highs. Meanwhile, profitable large-cap stocks such as Microsoft, Apple, and others among the Magnificent 7 have performed well despite rate fluctuations.
Cryptocurrency prices were affected as rates appeared to rise, but with expectations of near-term rate cuts, crypto prices have surged. The launch of Bitcoin ETFs helped push Bitcoin to a record high in March. Prospects of lower rates and inflows into ETFs have also lifted Ethereum’s price.
2. Could lower interest rates derail the stock market?
Stocks and cryptocurrencies experienced significant volatility as investors priced in rising interest rates. But what happens over the next six months, as markets now anticipate a Fed rate cut in September?
Expectations of lower rates have already helped support interest-rate-sensitive sectors such as banks and real estate investment trusts (REITs). Small-cap indices like the Russell 2000 have performed well in recent weeks as markets begin pricing in the likelihood of upcoming rate cuts. At the same time, the prospect of imminent easing hasn’t boosted mega-tech names like Apple, Microsoft, and Amazon, whose share prices have fallen substantially from their 52-week highs.
Market watchers remain divided on whether the Fed has kept rates too high for too long—and whether that’s already reflected in current prices. This uncertainty itself fuels market volatility.
"I’m concerned that holding rates high could push the economy into a short-term recession, just as I worry about cutting too early," said Dan Raju, CEO of brokerage platform Tradier.
"The narrative of a soft landing seems established, yet many market participants still doubt whether it will actually happen," said Brian Spinelli, Co-Chief Investment Officer at wealth advisory firm Halbert Hargrove in Long Beach, California.
Meanwhile, markets continue to reprice the economic environment based on expectations of lower rates.
Currently, the 10-year Treasury yield stands at 4.12%, well below its 52-week high of 4.99% reached in October last year—a level from which it has steadily declined in recent weeks after a sharp rise earlier in the year.
Now, short-term rates are significantly higher than long-term rates—the so-called inverted yield curve—leading many market observers to still expect a recession in 2024. A recession could trigger further stock market declines until investors can assess the duration and depth of any downturn. But that doesn't necessarily prevent occasional market rallies.
3. How interest rates affect cryptocurrency and commodity markets
Two other major asset classes reacted differently amid higher interest rates. While cryptocurrency prices plunged alongside other risk assets in early 2022, many commodities including oil saw sharp price increases—though much of that surge proved temporary. As the Fed’s pace of rate hikes slowed and paused in 2023, both oil and cryptocurrencies found some support. Now, with rate cuts on the horizon, both are receiving additional tailwinds.
Cryptocurrencies are often touted as panaceas for various issues—be it inflation, low interest rates, loss of purchasing power, or dollar depreciation. When crypto prices rise, these benefits seem easy to believe and appear unrelated to other assets.
"The reality is that crypto prices have shown directional influences similar to those affecting retail stock investors," said Raju. "Generally, high interest rates scare investors away from risky investments like crypto, while rate cuts are viewed positively by the crypto investing community."
Indeed, crypto and other risk assets responded to tightening liquidity, beginning to fall when the Fed announced its intention to raise rates in November 2021, and continuing to decline throughout 2022 as the Fed aggressively implemented hikes. Additionally, risks surrounding crypto exchanges (such as FTX) damaged trader confidence in these digital assets.
However, instability in the banking sector prompted many traders to bid up cryptocurrencies, believing the future rate-hike path would be more moderate. As the 10-year Treasury yield peaked in October 2023 and then declined, risk assets rallied as the path toward rate cuts became clearer.
Yet, other factors also contributed to crypto’s gains over the past year.
Spinelli noted that the approval of spot Bitcoin ETFs was a significant driver of crypto prices.
In early January, the SEC approved 11 asset management firms to offer Bitcoin ETFs. Anticipation of this approval helped crypto end 2023 strongly, and subsequent capital inflows into the new ETFs pushed crypto to record highs in March.
Regarding commodities, many have moved away from recent highs, partly due to supply constraints and modest downward pressure from higher interest rates. However, expectations of rate cuts have helped keep oil prices from falling sharply below $70 per barrel in 2023 and 2024. Additionally, announcements by some oil-producing nations to reduce supply have tightened the market and supported prices.
For instance, after peaking around $123 in June 2022, oil prices steadily declined to about $70 per barrel. In 2023, oil bottomed around $70 and fluctuated between $70 and $80, briefly rising to $90 mid-year. Oil began 2024 near $70, rose again, but fell below $80 by early June 2024 and has continued to decline in recent weeks.
4. How should interest rates affect your investment strategy?
Interest rates, inflation, and uncertainty—all combine to create a stew of volatility for investors. Amid such turbulence, caution may be prudent.
However, for most investors, the best way to navigate such markets is to stick to a long-term investment plan. For many, that means continuing to invest regularly in a diversified portfolio of stocks or bonds, largely ignoring the noise from around the world. For others, the plan may involve buying and holding well-diversified index funds. Either way, don’t let emotions interfere with sound long-term strategies.
While short-term traders may fret over rate moves and try to time the onset of a recession, maintaining perspective is crucial. Instead of trying to pinpoint the perfect time to sell, buy-and-hold investors can use market volatility to their advantage—seeking opportunities to increase investments when conditions are favorable.
"For long-term investors, pullbacks represent attractive buying opportunities," said Greg McBride, CFA, Bankrate’s chief financial analyst.
Periods of market decline can be attractive times to add to portfolios at a discount. As legendary investor Warren Buffett once said, "Be fearful when others are greedy, and greedy when others are fearful." In other words, when few believe stocks are attractive, their prices tend to be cheaper.
5. Final thoughts
Interest rates rose rapidly in 2022 and 2023, but investors now expect the Fed to cut rates soon. Those with a long-term investment horizon may view market downturns as ideal opportunities to acquire quality investments at discounted prices.
What if stock valuations plunge? On that, Buffett also offered wisdom: "Opportunities come rarely. When it rains gold, reach for a bucket, not a thimble."
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