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For two years the prospect of higher interest rates has been affecting markets, but the direction of rates has now hit a turning point. In three of its last four meetings, including the one ending November 1, the Federal Reserve has opted to hold rates steady, after raising rates 11 times in this economic cycle. Now, few analysts doubt that the end of rising rates is near, as inflation – which fell to 3.7 percent in September– comes increasingly under control.
Higher rates have been playing out on stocks, cryptocurrency and commodities such as oil over the last two years. But what can investors expect from here and how long will the rate environment impact markets?
Higher rates and recession fears losing effect on the market
While the Fed has already raised rates eleven times during this tightening cycle, it’s easy to spot when markets really sat up and took notice that the central bank wasn’t kidding that it was about to recalibrate monetary policy. It was November 2021 when cryptocurrency and many of the riskiest stocks peaked.
“The stock market will never not worry about future interest rates,” says Steve Azoury, head of Azoury Financial in Troy, Michigan. “The cost of borrowing impacts all areas of investing, purchasing and savings. Just the anticipation of what may happen is enough to cause a stock market reaction.”
But higher rates seem to be frightening investors less these days, as they anticipate the future path of interest rates may be peaking.
“I think markets are far less anxious about interest rate hikes now than in Q3 and Q4 2022,” says Dan Raju, CEO of Tradier, a brokerage platform. “With the better-than-expected recent inflation numbers, the Fed and investors feel like they have some control on inflation. It seems now everyone sees a path to an eventual holding off of rate hikes.”
While major stock indexes such as the Standard & Poors 500 spent most of 2022 in a funk, they’ve fared alright in 2023, though they’re off their highest levels of the year. The S&P 500 has risen about 10 percent, while the Nasdaq Composite has climbed around 24 percent.
But what about the highly expected recession? The market’s recent relative strength suggests that investors may be more optimistic – or at least, less pessimistic – than they were in 2022.
Whether a recession happens and its potential severity are major uncertainties now, says Brian Spinelli, co-chief investment officer at wealth advisor Halbert Hargrove in Long Beach, California.
So after a run-up in 2023, there may yet be plenty of room for markets to fall further if the economy worsens significantly.
“When the Fed introduced restrictive monetary policies by increasing rates in 2022, this caused equity markets and cryptocurrencies to appropriately decline in valuation,” says Octavio Sandoval, director of investments at Illumen Capital.
Unprofitable high-growth stocks had a quite rough 2022, and while prices have firmed up in 2023, that doesn’t mean these stocks are anywhere close to their prior highs. For example, software stocks such as Cloudflare, Zoom Video Communications and Confluent are worth less than half their all-time highs.
When it comes to crypto, Bitcoin is still down around 46 percent from its all-time high set in November 2021, despite a surge following the blowup of Silicon Valley Bank. The second-largest cryptocurrency Ethereum has dropped 61 percent over a similar period as riskier assets have struggled.
Will rising rates and inflation continue to derail stocks?
Stocks and cryptocurrency have endured notable volatility as investors have factored in rising rates. But what’s in store for the next six months, with many rate hikes already completed and perhaps no more in the cards?
“Cost of capital for companies is going up, there are arguably tighter lending conditions for consumers,” says Spinelli.
With less money sloshing about in financial markets, that’s a net minus for investments as a whole. Still, investments such as big tech stocks have done well in 2023, while others – notably regional and small bank stocks – have fared poorly, as investors fretted about rising rates, deposit flight and overpriced commercial real estate. But investors have a notable habit of looking beyond today’s news.
Market watchers are still divided as to whether the Fed will do too much or too little and whether that’s already priced into stocks. This uncertainty itself drives volatility in the markets. In the meantime, markets continue to re-adjust to the economic environment with the hopes that the central bank gets a better handle on inflation and reins it in. That looks to be the case after the last few months of inflation data, however.
The bellwether 10-year Treasury, now offering a 4.9 percent yield, is near its 52-week high of 4.99 percent set last month, after a surge in the last few months.
Now, with short-term rates well above longer-term rates – a so-called yield-curve inversion – many market watchers are expecting a recession to occur in 2024. A recession would likely push the stock market even lower until investors can begin to gauge the length and depth of any upcoming downturn. But that may not stop intermittent rallies.
How higher interest rates have affected crypto and commodities markets
Two other major asset classes have had varied responses in the face of higher rates. While cryptocurrency prices have plummeted along with other risky assets, many commodities spiked higher in early 2022, including oil, but many of those moves proved short-lived. With rising rates expected to slow or stop in 2023, both oil and crypto seem to have found some support.
Cryptocurrency has often been touted as a cure-all for what ails you, whether that’s inflation, low interest rates, lack of purchasing power, devaluation of the dollar and so on. Those positives were easy to believe in as long as crypto was rising, seemingly regardless of other assets.
“Higher rates generally lower appetite for riskier investments and that is likely one of the causes for a significant pullback in digital asset prices over the last year,” says Spinelli.
Indeed, cryptocurrencies responded to reduced liquidity as did other risky assets, by falling when the Fed announced in November 2021 its intention to raise rates and then throughout 2022 as the Fed aggressively followed through. On top of that, the blow-ups of individual cryptocurrencies and exchanges such as FTX have hammered traders’ confidence in these virtual assets. But instability in the banking sector led many traders to bid up cryptocurrency, in the belief that the future path of rate increases would be less severe.
Many commodities have been well off their recent highs, as fewer supply constraints and higher interest rates work to take them down a few notches. But the expectation that the Fed will soon be done raising rates has helped keep oil from falling below $70 a barrel for much of 2023. Pricing has also been supported by petroleum-producing countries that have announced supply cuts.
For example, the price of oil had been in a steady downtrend to around $70 per barrel after peaking at around $123 in June 2022. But oil hit a bottom in early December at around $70 and had been floating between there and $80 for much of the year, before bounding to $90 in recent months.
How should rising rates impact your investing strategy?
Rising rates, high inflation and uncertainty – all create a stew of volatility for investors. With so much volatility, investors may want to tread cautiously.
However, the best way for most investors to approach this type of market is to stick to the long-term game plan. For many, the long-term plan means continuing to invest regularly in a diversified portfolio of stocks or bonds and mostly disregarding the noise around the world. For others, the game plan may involve buying and holding well-diversified index funds. Either way, don’t let emotions get in the way of an effective long-term investing plan.
While short-term traders may be sweating rising 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, the pullbacks represent attractive buying opportunities,” says Greg McBride, CFA, Bankrate chief financial analyst.
Downturns can be an attractive time to add to your portfolio at discounted prices. As investing legend Warren Buffett once said, “You pay a very high price in the stock market for a cheery consensus.” That is, stocks are cheaper when few agree that they’re an attractive investment.
Interest rates rose fast in 2022 and 2023, and the big question right now is just how long they’ll stay there. Those investors with a long-term investing horizon may view it as an ideal time to pick up some quality investments at bargain prices.
And if stock valuations plummet? Buffett has some wisdom for that situation, too: “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.