The Federal Reserve is expected to increase interest rates at its meeting from January 31st to February 1st, following seven rate hikes in 2022. This increase is predicted to be a 0.25% rise in the benchmark Fed funds rate, as indicated by the CME FedWatch tool. The Fed may continue to raise rates in the future to control inflation, reaching 6.5% in December 2022. The impact of rising rates can be seen on stocks, cryptocurrencies, and commodities such as oil, but it is unclear what the future holds for investors and how long this rising-rate trend will affect markets.
The Market No Longer Reacting to Higher Rates and Recession Concerns
The stock market’s reaction to the Federal Reserve’s seven interest rate hikes during this tightening cycle was most noticeable in November 2021, when cryptocurrency and many high-risk stocks peaked. Despite the cost of borrowing affecting all areas of investment, the anticipation of future interest rates is enough to cause a market reaction, according to Steve Azoury, head of Azoury Financial. However, the markets seem less anxious about interest rate hikes now, as the Fed and investors feel they have more control over inflation. The better-than-expected recent inflation numbers and a path to an eventual halt in rate hikes indicate this.
Some Major stock indexes, such as the S&P 500, struggled for most of 2022 but have found stability since October and have started the new year well, with the S&P 500 up 4% and the Nasdaq Composite up 8%. The recent relative strength of the market suggests that investors may be more optimistic about the future, or at least less pessimistic than in 2022. However, the potential for a recession and its severity remain major uncertainties. Stocks are forward-looking, and the current market prices may anticipate a mild recession. If a deeper recession occurs, it will likely not be priced into the markets currently.
The economy worsening significantly could result in further declines in the market. The Federal Reserve’s restrictive monetary policies by increasing interest rates in 2022 caused a decline in the valuation of equity markets and cryptocurrencies, according to Octavio Sandoval, director of investments at Illumen Capital.
Unprofitable high-growth stocks had a difficult time in 2022, and although prices may have stabilized recently, they are still far from their prior highs. For instance, software stocks like Cloudflare and Datadog are worth less than half of their all-time highs. In the case of cryptocurrencies, Bitcoin is still down more than 65% from its all-time high set in November 2021. Ethereum, the second-largest cryptocurrency, has experienced a similar drop as riskier assets have struggled.
Will Continued Increases in Interest Rates and Inflation Disrupt Stock Performance?
Stocks and cryptocurrency have experienced significant fluctuations as investors have taken into account the rising interest rates. However, what lies ahead for the next half year, with several rate hikes already executed and possibly more to come?
“The cost of capital for companies is increasing, lending conditions for consumers are becoming tighter, and there is uncertainty about the level at which the Fed will halt its rate hikes to control inflation,” says Spinelli.
With less liquidity in the financial markets, this is a negative for investments, but investors often look beyond current events.
“The market appears to be anticipating a pause in rate hikes by the Fed in Q1 2023,” says Spinelli. “While the Fed says they will continue to raise rates to curb inflation, the market is currently doubting their stance.”
Market observers are still divided on whether the Federal Reserve will do too much or too little and if that is already reflected in stock prices, causing market uncertainty and volatility. Meanwhile, the market is adjusting to the Fed’s aggressive rate hikes, hoping the central bank can better manage inflation. This appears to be the case, as inflation data in recent months has improved, and market sentiment has become less pessimistic.
The benchmark 10-year Treasury yield, currently at 3.5%, has dropped from its 52-week high of 4.33% in October, indicating that investors are anticipating a slowdown in the economy in the near term.
With short-term rates higher than long-term rates, a phenomenon known as yield curve inversion, many market observers predict a recession in 2023. A recession could push the stock market further until investors can determine the duration and intensity of the economic slowdown. However, this may not prevent short-lived bear market rallies.
“Retail investors are confident that the Fed will announce a smaller rate hike this month and I anticipate a recovery in the technology sector following the upcoming meeting,” says Raju. “This situation is not over yet.”
The Impact of Increased Interest Rates on Cryptocurrency and Commodity Markets
The crypto and commodities markets have responded differently to the rising interest rates. Cryptocurrency prices dropped along with other risky investments, while some commodities, such as oil, saw a brief surge in early 2022. However, these gains were short-lived. With expectations of the interest rate hikes slowing or coming to a halt, oil, and crypto seem to have stabilized.
Cryptocurrency was seen as a solution for various financial problems like inflation, low-interest rates, and devaluation of the dollar. However, these positive views changed as the cryptocurrency prices declined along with other risky investments due to higher interest rates reducing the risk appetite.
The Fed’s announcement of rate hikes in November 2021 and its aggressive actions throughout 2022 also affected the liquidity of cryptocurrencies, resulting in a significant decrease in digital asset prices. The future of crypto in 2023 will depend on the level of risk tolerance among investors, which currently appears to be low.
The prices of many commodities have also declined due to fewer supply constraints and higher interest rates. However, the expectation of the Fed’s pause in interest rate hikes has recently helped keep oil prices from falling below $70 per barrel. For instance, oil prices had been declining steadily to reach $74 per barrel after hitting a peak of $123 in June 2022. But oil hit a recent low of around $70 in early December 2022.
How can increase interest rates impact your investment strategy?
The rising rates, high inflation, and uncertainty can make for a tumultuous investment environment, causing some investors to tread cautiously. Nevertheless, it is recommended that most investors stick to their long-term strategy, whether regularly investing in a diversified portfolio of stocks holding well-diversified index funds. Emotions should not interfere with a successful long-term investment plan.
Short-term traders may feel pressure from the volatility brought on by rising rates. Still, market downturns present opportunities for buy-and-hold investors to add to their portfolios at discounted prices. As investment guru Warren Buffett said, “You pay a high price in the stock market for a positive outlook.” This means stocks become cheaper when fewer people view them as attractive investments.
The rapid increase in interest rates in 2022 has left investors wondering about the potential growth rates in 2023. For those with a long-term investment approach, it may present an opportunity to acquire high-quality investments at a discount. If the stock market continues to experience a decline, it’s a good reminder to follow the advice of Warren Buffett and make the most of opportunities as they arise.