Impacts of the Federal Reserve on Stocks, Cryptocurrencies, and Other Financial Investments
A Fresh Spin on the Impact of Interest Rates on Markets in 2025
Interest rates have had a significant influence on stocks, cryptocurrencies, and commodities over the past few years, with higher rates causing a downturn in values. Now, as short-term rates start to drop, it's essential to understand what this shift means for investors and how long it will influence market performance.
Following a 25 basis point reduction in December 2024, the Federal Reserve has left interest rates untouched at their current range of 4.25% to 4.50%. The Fed's hesitation to trim rates further can be attributed to potential disruptions and inflation caused by President Donald Trump's tariffs. However, further rate cuts may be on the horizon in 2025, helping prop up the U.S. economy.
Navigating Investment Landscapes
Interest rates play a pivotal role in shaping the economy, and the Federal Reserve uses them as a vital tool to influence market activity. Lower interest rates can stimulate economic growth by making borrowing cheaper, whereas increases can slow down economic activity by making credit more expensive, acting as a measure to combat inflation.
During the previous tightening cycle, the Fed hiked interest rates 11 times. It was apparent when the market started to take notice that the central bank was serious about recalibrating monetary policy – this occurred in November 2021, when cryptocurrency and many high-risk stocks peaked.
“When the Fed implemented restrictive monetary policies by increasing rates in 2022, this caused equity markets and cryptocurrencies to appropriately decline in valuation,” says Octavio Sandoval, principal at Illumen Capital.
Steve Azoury, head of Azoury Financial in Troy, Michigan, echoes this sentiment, stating, "The stock market will never not worry about future interest rates. 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."
As rates were increasing, many stocks were decreasing, predicting slower economic conditions. However, when investors received a clearer picture of the end of rising rates in 2023, the outlook became more optimistic. This shift was evident in the performance of major stock indexes such as the S&P 500, which spent most of 2022 in a funk due to rising rates, but fared well in 2023, posting a 24% gain.
An Unpredictable Ride Ahead
Despite strong run-ups in 2023 and 2024, there may be plenty of room for markets to fall if the economy worsens. In fact, following Trump's announcement of tariffs, the S&P 500 experienced a "correction," a decline of more than 10%, while the Nasdaq entered a bear market, plunging 20% or more from its recent high.
High-growth stocks, particularly software stocks such as Cloudflare, Zoom Communications, and Confluent, were hit hard in 2022. While prices have improved in the last couple of years, these stocks have yet to approach their former highs. Stalwarts like Microsoft, Apple, and others in "The Magnificent 7" have set successive all-time highs, even after a lackluster 2022. However, they've shown mixed performance in 2025, as the Fed has held steady on rates.
Cryptocurrency prices struggled as interest rates threatened to rise in 2022, but when rates began to retreat, crypto prices rebounded in 2023 and continued to rise throughout 2024. The approval of Bitcoin ETFs has pushed Bitcoin's price higher, and the prospect of lower rates has given Ethereum a boost as well.
A Tale of Two Scenarios: Lower Interest Rates and their Impact on Stocks, Cryptocurrencies, and Commodities
Lower interest rates generally make it easier for money to flow through the economy, helping to boost markets or at least support them from declining more. As lower short-term rates aid the economy, stocks begin to rise due to the prospects for higher corporate profits. Lower short-term interest rates also make stocks and other risky investments more attractive compared to alternatives such as bonds.
When short-term rates increase or are expected to rise, stocks endure notable volatility as investors factor in rising rates. In other words, stocks begin pricing in a slowing economy and lower profit growth due to higher rates.
The Federal Reserve lowered short-term interest rates in late 2024, but longer-term interest rates have generally risen during this period. The 10-year Treasury, now providing a 4.45% yield, is above its 52-week low of 3.60% set in September 2024, leading investors to demand higher long-term rates to protect against potential inflation. If long-term interest rates continue to rise, this could pose a threat to stock prices.
Steering Your Investment Strategy
Interest rates, inflation, and uncertainty create a volatile landscape for investors. However, the best approach for most investors is to remain focused on the long-term and stick to a diversified portfolio of stocks or bonds. Instead of reacting to market noise, buy-and-hold investors can use market volatility to their advantage and seek attractive buying opportunities during downturns.
As investing legend Warren Buffett once said, "You pay a very high price in the stock market for a cheery consensus." This translates to stocks being cheaper when few agree that they are an attractive investment, making downturns an ideal time to pick up quality investments at reduced prices.
Final Thoughts
Interest rates have a significant impact on not only the financial markets but also the overall economy. While the Fed has begun lowering rates and potentially plans to do so again in 2025, the ongoing uncertainty around tariffs and inflation risks means the market's response may be uneven and volatile. Investors with a long-term horizon may view any downturn as an opportunity to acquire quality assets at discounted prices.
- As the Federal Reserve plans to lower interest rates again in 2025, understanding the implications for investors is crucial. The drop in interest rates may stimulate economic growth by making borrowing cheaper, potentially influencing stock, cryptocurrency, and commodity markets.
- Given the ongoing uncertainty around tariffs and inflation risks, the market's response to lower interest rates may be uneven and volatile. Investors with a long-term horizon may view any downturn as an opportunity to acquire quality assets at discounted prices.
