- A year ago, the Federal Reserve began raising interest rates at its fastest pace in recent memory.
- His aggressive campaign drove up borrowing costs, fueling the sell-off in stocks and bonds.
- Two of the most publicized corporate meltdowns of all time – FTX and SVB – have their roots in Fed rate hikes.
It’s been a year since the Federal Reserve began raising interest rates at the fastest pace in recent history — and what followed was a turbulent 12 months for markets and a few once-promising companies.
The U.S. central bank has raised borrowing costs from near zero to just under 5%, beginning with its first increase on March 16, 2022. This is the fastest pace of tightening in decades, with policymakers making four outrageous hikes in a row.
The Fed’s goal was to crush runaway inflation – but it claimed some high-profile scalps along the way.
Lender Silicon Valley Bank went bankrupt and FTX imploded after borrowing costs increased. US stocks and Treasuries fell as the era of easy money drew to a close, although the US dollar experienced a historic tear.
Fed policymakers say they’re not done yet, with inflation just starting to ease. Here’s how their campaign drove some of the biggest market moves of the past year.
Between the early days of the COVID-19 pandemic and the end of 2021, US stocks have crashed. Low borrowing costs and loose fiscal conditions helped push stock prices higher.
But when interest rates rise, future cash flows fall for businesses. This is because it becomes more expensive for them to borrow money.
So the year of Fed rate hikes crushed equities.
The S&P 500 fell 18% between March and October last year. Although it pared some of those losses, the benchmark US stock index is still down 12% from a year ago. Meanwhile, the tech-heavy Nasdaq Composite has tumbled 16% since the gains began.
“Equities had become dependent on low interest rates as a crutch,” Dan Kemp, CIO at Morningstar Investment Management, told Insider.
“Had valuations been lower, the reaction to Fed rate hikes would have been much less severe.”
The year was even more difficult for fixed income investors. When interest rates rise, traders can find better returns by putting their money in a savings account than by holding bonds, so prices tend to plunge.
Yields, which rise when prices fall, have soared over the past 12 months. Yields on 2-year US Treasuries rose 209 basis points to over 4%, while yields on 10-year notes rose 130 basis points to just under 3.5%.
Meanwhile, Bloomberg’s Global Bond Index – which tracks the price of fixed income investments around the world – fell into its first bear market in more than three decades in September, after prices fell more than 20%.
“It’s clearly been a very tough year for bond investors — the toughest they’ve seen in decades,” Kemp said. “We are only now at a point where prices seem closer to fair value.”
FTX and Silicon Valley Bank
The Fed’s rate hike fueled two of the biggest corporate meltdowns in US history – crypto exchange FTX and tech-focused lender Silicon Valley Bank.
Rising borrowing costs have sent cryptocurrencies into a brutal bear market, with the price of bitcoin dropping 39% over the past year. FTX boss Sam Bankman-Fried has reportedly responded by using client money to support his trading company Alameda Research – and now he’s in the US awaiting criminal trial on eight counts, including fraud .
“Although it was accused of fraud, you can argue that a Fed hike cycle exposed it, as it reversed crypto enthusiasm, which ultimately exposed the company’s misdeeds to the company,” Deutsche Bank chief executive Jim Reid said in a research note. .
Meanwhile, SVB collapsed last week – and rising interest rates were a major factor in its demise. SVB lost $1.8 billion on its bond portfolio as fixed income prices fell, while its deposit base dried up due to the growing reluctance of tech startups to go public .
“In essence, the Fed is behind this run on the banks,” market guru Larry McDonald told CNBC last Friday.
Not all traditional assets have suffered over the past year.
The US dollar index recorded a gain of 16% between March and September. And the index, which tracks the value of the greenback against six other currencies, is up 7% since the Fed’s first hike.
Rising interest rates in a given country tend to strengthen its currency, as it attracts foreign investors looking for higher returns.
“It was a pretty bumper year for the dollar as the Fed continued the most aggressive monetary tightening in decades,” OANDA market analyst Craig Erlam told Insider.
“The US probably needs to go further on interest rates and will likely end up with a higher terminal rate than most of its peers, which could further support the dollar,” he said.