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WHAT HAPPENED?
the S&P500 went down 2% on Wednesday, tech stocks took a huge beating and the NASDAQ fell 3%, Ethereum went down to $3,500, and Bitcoin fell to the low 43,000 range so we had a huge market correction. Was this week the start of the market crash of 2022?
THE REAL INVESTOR QUESTION:
Why do stocks, specifically tech stocks, and even things like Bitcoin go down when people are afraid of inflation? Think about it – if prices are going up – don’t you want money to be invested in assets? Isn’t Bitcoin supposed to be a hedge against inflation? That’s a really good question. In order to understand the answer – you have to learn how the Federal Reserve controls the interest rates.
HOW DO INTEREST RATES ACTUALLY WORK?
Enter the Federal Fund Rate. That is the cost at which commercial banks – banks like Wells Fargo, Chase, Citibank, etc. borrow or lend their money to other banks. Why would banks borrow money from other banks – can’t they just print it? No – they can’t. They need to borrow money in order to meet what are called “Overnight Reserve Requirements”.
Banks lend their money to us but they can’t lend all their money out because if people go to withdraw, the banks need to have money in their vault, which is why they are required to hold a minimum in relation to how much they lend out – that is the law. If banks have too little – they have to borrow from other banks with “excess capital reserves”. Today that rate fluctuates between 0% and .25% so it’s very cheap for banks to lend, and borrow.
THAT STILL DOESN’T EXPLAIN IT:
The Federal Reserve has $8.7 trillion dollars on their balance sheet – if you go to their website – https://www.federalreserve.gov – that’s how much money they have in assets – think of this as their “investment portfolio”. The report is now showing us that the Fed wants to start selling the assets off after they’ve “tapered” (stopped buying, aka money printer go brrr). Normally they would have waited a couple years before doing that. And how it affects us, is the risk vs reward in the form of increased interest rates for bonds.
HOW DO BOND RATES AFFECT INVESTORS?
Once the federal reserve starts to sell the bonds, the price of those bonds will fall but their yields will go up. That’s just how it works. Bond yield, dividend yields, are inverse to prices. If prices go up – yields go down, if prices fall, yields go up. That’s how rates are “truly controlled”. They’re just influenced by way of buying or selling or buying bonds and other assets.
As of right now – the Fed has not started selling but they told they’re highly considering sometime before the summer of this year – and once they sell, interest rates on bonds will go up which will make the fixed income assets much more attractive to investors. In fact, since the Fed announced they could be selling, the 10 year treasury bond yield went up to 1.7%.
I STILL DON’T GET IT:
The reason tech stocks with high valuations are so affected, is because bond interest rates affect how we value the future cash flow of that company. This is called the “DCF” or discount cash flow model. https://cnb.cx/33fTXS4
HOW DOES IT WORK?:
Watch the video to find out how all of this affects Bitcoin and stocks.
*None of this is meant to be construed as investment advice, it’s for entertainment purposes only. Links above include affiliate commission or referrals. I’m part of an affiliate network and I receive compensation from partnering websites. The video is accurate as of the posting date but may not be accurate in the future.