Published By Bankrate

Written By: James Royal

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The Federal Reserve is set to raise interest rates at its Dec. 13-14 meeting after hiking rates six times already this year. The nation’s central bank is expected to lift the benchmark Fed funds rate by 0.50 percentage point, according to the CME FedWatch tool, though a small minority expects rates to rise 0.75 percentage point.

It’s likely not the last increase for this economic cycle, either. The odds are high that the Fed will raise rates at its February 2023 meeting as it attempts to get inflation – which hit 7.7 percent in October, compared to a year ago – under control.

Higher rates have been playing out on stocks, cryptocurrency, commodities (such as oil), as well as many other investments over the last year. But what can investors expect from here and how long will the rising-rate environment impact markets?

Higher rates and recession fears continue to pressure the markets
While the Fed has already raised rates six times this year, 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 tighten monetary policy. It was November 2021 when cryptocurrency and many of the riskiest stocks peaked.

“The stock market is forward-looking, so just the expectation of higher rates has had an impact,” says Caleb Tucker, director of portfolio strategy at Merit Financial Advisors in the Atlanta area.

It’s been mostly downhill for the broad-based Standard & Poor’s 500 Index in 2022, and more so for riskier investments. The Dow Jones Industrial Average and the Nasdaq Composite have been in a similar situation, as higher rates and the expectation of still-higher rates kept any sustained advances in the indexes under wraps.

“From the beginning of 2022, stocks have pulled back and interest rates have moved higher due to expectations the Federal Reserve would hike interest rates repeatedly to corral inflation,” says Greg McBride, CFA, Bankrate chief financial analyst.

Even after a bit of a fourth-quarter bear-market rally, the S&P 500 is down about 17 percent since the start of the year, while the tech-heavy Nasdaq Composite is down even more, about 30 percent, and the Dow Jones Industrials is still off 7 percent or so. Still-riskier investments have fared much worse.

“Assets that have benefited most from ultra-low interest rates – think high-octane growth stocks with earnings well off into the future and non-cash-flow-generating assets like cryptocurrencies – have been hit hardest as markets adjust to the reality of higher interest rates,” says McBride.

For example, high-growth stocks such as Cloudflare and Carvana have fallen about 80 percent and 98 percent, respectively, from their highs in 2021.

Top cryptocurrency Bitcoin has fallen about 75 percent from its all-time high in November 2021. The second-largest cryptocurrency Ethereum has seen a similar drop, down 74 percent, although it recently went through something called “the merge.”

Will rising rates and inflation continue to derail stocks?
Stocks, cryptocurrency and commodities have endured notable volatility since the start of 2022 as investors have factored in rising rates. But what’s in store for the next six months, with many rate hikes already completed and more seemingly in the cards?

With less money sloshing about in financial markets, that’s a net minus for investments as a whole, but investors have a notable habit of looking beyond today’s news.

“Rising interest rates will always trigger a period of stock market volatility,” says Dan Raju, CEO of Tradier, a brokerage platform.

But market watchers are 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 these aggressive rate hikes with the hopes that the Fed gets a better handle on inflation and reins it in. As a result, further rate hikes will likely make the market even rockier for investors.

After the rate hikes of 2022, the market seems to be pricing in the prospect of a recession. The bellwether 10-year Treasury, now offering a 3.5 percent yield, is off its 52-week high of 4.33 percent set in October. The decline suggests investors are becoming more bearish, expecting the economy to slow in the near term, relative to their expectations of two months ago.

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 2023. A recession would likely push the stock market even lower until investors can begin to gauge the length and depth of any upcoming economic downturn.

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, wheat and lumber, but many of those moves proved short-lived.

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.

“Crypto assets had been seen as an inflation hedge, but recently they have acted more like other risk assets such as stocks,” says Tucker. “Higher rates will be a headwind for crypto assets going forward.”

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, high-profile blow-ups of individual cryptocurrencies and exchanges such as FTX have hammered traders’ confidence in these virtual assets.

While the prices of some commodities skyrocketed early in 2022, in many cases those commodities have retraced some, if not all, of those moves higher. Many commodities are well off their recent highs, as fewer supply constraints and higher interest rates work to take them down a few notches.

For example, the price of oil has been in a steady downtrend to around $74 per barrel after peaking at around $123 in June. The move lower in such an important commodity signals investors’ expectations of a slowdown not just in the U.S., but also globally.

Similarly, the price of wheat spiked in the early days of the Russian invasion of Ukraine, but prices are now well below where they were in the months before that crisis. Lumber, which peaked at more than $1,400 in March, has now fallen to $415. And steel has fallen about 30 percent from its 52-week high in March.

Higher rates and an aggressive Fed seem to have persuaded the markets that an economic slowdown is on the way. Further rate hikes are likely to push commodities markets still lower.

How should rising rates impact your investing strategy?
Rising rates, high inflation and international conflict – all create a stew of volatility for investors. And with commodities and stocks signaling a slowdown, 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 McBride.

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.

Bottom line
Interest rates rose fast in 2022, and the big question right now is just how high they will go. 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 continue to plummet? Buffett has some wisdom for that situation, too: “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”

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https://www.bankrate.com/investing/federal-reserve-impact-on-stocks-crypto-other-investments/

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