Prices in the economy have the role of signaling information to economic agents, for example, if there is a greater or lesser demand for oil, a price increase will occur to signal this (considering all other factors constant).
An economy’s interest rate plays the same role, often referred to as “the price of money.” However, this signal is flawed, given all the interference by Central Banks in today’s global economy. These interventions are supported by Modern Money Theory (MMT).
The price intervention, that all economic agents understand to be wrong, is not seen as so harmful by most of these agents when it comes to interest rates. A common mistake due to the fact that this intervention has been the norm since 1942, in the case of the United States.
This intervention is one of the reasons that underpin Bitcoin and makes me bullish on its thesis. A medium of exchange with a solid store of value does not have this kind of interference.
When it comes to the impact of interest rates on investments, including the crypto asset market, the consequences are many and due to several factors. Examples considering an increase in the interest rate of an economy:
1. Decrease in valuation: companies are now valued at a lower value, as the valuation process takes into account a discount rate, which can be the basic interest rate or another rate influenced by it.
2. Greater allocation to government bonds: pension funds, asset managers and other institutional investors almost automatically position themselves more in this type of asset, given the need for yield targets (other assets, such as stocks, tend to value less).
3. Opportunity cost: the yield (or appreciation) of certain assets must offset risk-free assets that are pegged to the interest rate; in other words, risky assets should pay off relatively better, given that the risk-free assets now have a greater benefit.
That said, when there is a rise in the interest rate of an economy, the stock market, crypto market and other risky assets tend to lose investment. Meanwhile, the market for interest rate-linked assets, such as government bonds, tends to heat up.
There are more factors that an interest rate can affect, such as inflation (and demand for currency), exchange rate and loan demand that would be left for a later deeper analysis of the issue.
In short, this is why investors should always be aware of the movement of basic interest rates in their country and in the main country of the global economy — the United States. In the US, this rate is called the Fed Funds Rate.
Investments are your life, almost literally. So be aware of the important details that impact them.