The US Federal Reserve held its widely awaited Jackson Hole Symposium yesterday where it signaled more tightening and dashed any hope of an early pivot, or moving from rate hikes to rate cuts. Stocks and cryptos crashed after Fed chair Jerome Powell’s comments.
The price of action of both stocks and cryptos was similar to the previous Friday when the minutes of the Fed’s July meeting were released. Before the minutes, markets started to believe that a Fed pivot was almost on the horizon.
However, the minutes showed that the Committee members favor higher rates and many even want an even aggressive tightening to tame inflation. While US inflation dropped sharply to 8.5% in July, from a multi-decade high of 9.1% in June, it is still quite high for comfort. Higher inflation and the resultant rate hikes have especially taken a toll on growth stocks.
Fed’s Rate Hikes Have Hit Both Stocks and Cryptos
The US Fed has raised four times this year. It started with a 25-basis point rate hike but followed up with a 50-basis point rate hike in May. In June and July, it raised rates by 75 basis points each which was the steepest rate of hike since 1994. The Fed’s current round of tightening is the most hawkish since the early 1980s. But then, even the inflation rate is running at the highest level since the 1980s.
Fed’s rate hikes have impacted the price action of both stocks and cryptos. In June, the US 10-year Treasury yield almost hit 3.5%. However, yields plunged thereafter and fell to almost 2.5% as markets started to price in a pivot. The contraction in the US economy in both the first and second quarters of 2022 also made some believe that the Fed might not want to risk a recession with its rate hikes
Both stocks and cryptos rose in July on hopes that the Fed would now take a more dovish approach. However, on more than one occasion, the US Central Bank has said that taming inflation is its top priority. It just reiterated its stance at the Jackson Hole Symposium.
Fed Signals Continuation of Its Rate Hikes
At the Symposium, Powell said, that this is “no place to stop or pause.” Powell added, “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses.” Powell termed these “the unfortunate costs of reducing inflation,” adding “But a failure to restore price stability would mean far greater pain.”
Notably, the US job market has been quite strong and added 528,000 jobs in July. The unemployment rate is also running at 3.5%, a nearly five decades low. The July minutes also showed that Fed sees an increase in the unemployment rate in the back half of 2022 and sees it rising towards a more natural rate.
Both Stocks and Cryptos Crashed after Fed’s Jackson Hole Symposium
US stocks crashed last Friday when the July minutes were released and the price action after the Jackson Hole Symposium was similar and if anything, much worse. The tech-heavy Nasdaq fell almost 4% while the Dow Jones shed 1,000 points to close 3% lower. The S&P 500 also lost around 3.4%.
Cryptos also crashed and bitcoin barely managed to hold the $20,000 price level. While the largest cryptocurrency has fallen sharply, analysts have a bullish price prediction for bitcoin. Ethereum prices also dropped. The total crypto market cap has also plunged after peaking at over $3 trillion in November 2021 and is now down to just under $1 trillion.
What does Fed’s Aggressive Rate Hikes Mean for Stocks?
For stocks, Fed’s rate hikes are almost invariably negative. The rate hikes increase the risk-free rates and hence earnings get discounted at a higher rate, lowering their present value. Things are particularly bleak for growth stocks which have most of their earnings skewed towards the future.
The valuations of US stocks have come off their recent highs and analysts expect valuation multiples to contract even further as Fed continues with its tightening. Amid the rate hikes, many brokerages including Citi have raised their odds of a US recession.
Meanwhile, amid the rate hikes, value stocks and stocks of companies that pay high dividends can outperform. Value investing has anyways been outperforming growth over the last year.
Growth stocks rebounded sharply in July which eventually was the best month for US stocks since 2020. Now, with Fed signaling that it is not looking to cut rates anytime soon, growth stocks might feel some more pain.
How do Rate Hikes Impact Cryptocurrencies?
Cryptocurrencies have emerged as an alternative asset class and many financial advisors advise allocating some money to cryptos. However, the price action of cryptos has mostly mimicked that of other risk assets like stocks and cryptos. The Fed’s aggressive posture is a short-term negative for the cryptocurrency market also and yesterday’s price action is a testimony to that.
Rising interest rates not only raise the cost of borrowing for traders but also lead to a general sense of pessimism in risk assets like stocks and cryptos. Not all believe that rate hikes are negative and Bitstamp’s CEO believes that rate hikes are having a positive impact on its business.
Bond Markets Don’t Yet Believe that Rate Hikes Would Continue for Long
Powell was forthright in saying that it is not looking to cut rates anytime soon. Powell said, “The historical record cautions strongly against prematurely” lowering interest rates. He added, “We must keep at it until the job is done.”
That said, the bond markets are still not fully convinced that the Fed would keep raising rates for long and the 10-year Treasury yield is hovering just above 3% which is over 40 basis points below the 2022 highs. The bond market misread Fed once in 2022 as the yields plunged almost 100 basis points from the peak. Could the market be misreading Fed once again or would the US Central Bank pivot to a rate cut soon? We’ll have to wait and see.
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