Financial Knowledge: Where Does the Money Go When Interest Rates Drop?

superex · October 6

#SuperEx #Money #Crypto

In September 2024, the Federal Reserve announced its first rate cut since March 2020, ending a four-year period of high interest rates. The 25-basis-point cut lowered the federal funds rate to a target range of 5.25%-5.5%, marking the highest level in 23 years. The market responded immediately: U.S. equities rose while the dollar index declined slightly. Investors began reevaluating the future economic outlook. But what is the deeper economic logic behind the rate cut, and where will the released capital flow?

Rate cuts are a key tool used by central banks to adjust market liquidity and economic activity. The logic behind this is to stimulate consumption and investment by lowering borrowing costs, thereby driving economic growth. Under high interest rates, economic activity is usually suppressed as borrowing costs increase, leading to reduced spending and investment by both businesses and consumers. But when the central bank decides to cut rates, the cost of borrowing for banks decreases, and commercial banks can offer loans to businesses and individuals at lower rates. This, in turn, reduces the cost of personal mortgages, auto loans, and corporate financing, thereby increasing market liquidity.

Under a rate cut scenario, funds in the market tend to shift to higher-yielding assets, particularly the stock and real estate markets. With declining savings rates, investors gradually move their capital from low-yield savings and bond markets to stocks and other high-yield assets. At the same time, lower interest rates make it easier for businesses to obtain financing, thereby increasing production and business expansion. During this process, the real estate market often becomes a “safe haven” for investors. After a rate cut, mortgage rates decrease, lowering the cost of home ownership and stimulating increased housing demand, which in turn drives up real estate prices.

Moreover, rate cuts can strengthen the stock market. This is because the cost of borrowing for businesses falls, improving profitability, especially in industries reliant on debt financing, such as real estate, technology, and durable goods. Improved corporate profitability and increased market liquidity encourage more capital to flow into the stock market, driving stock and cryptocurrency prices higher.

The impact of rate cuts on individuals and businesses cannot be overlooked.

For individuals, lower loan interest rates make buying a home or car more affordable, and credit card and consumer loan interest rates also decrease, encouraging consumer spending. This increase in consumption further drives economic recovery. For businesses, the reduced financing cost from rate cuts can not only help expand production but also stimulate innovation and investment activities, thereby enhancing long-term competitiveness.

Impact of the Interest Rate Cut on the Crypto Market.

Following the Federal Reserve’s interest rate cut in September, the crypto market experienced notable fluctuations. The U.S. Dollar Index declined, increasing market liquidity and boosting investors’ appetite for high-risk assets. Consequently, mainstream cryptocurrencies like Bitcoin and Ethereum saw a rise in prices. Notably, Bitcoin surged by over 5% within a week of the announcement, breaking through the $27,000 resistance level again. Concerns over the potential depreciation of the U.S. dollar prompted investors to seek refuge in Bitcoin as a hedge, further bolstering market sentiment.

While rate cuts can bring liquidity and stimulus to the market, they can also lead to potential risks, such as asset bubbles and inflation. Therefore, investors must remain rational in responding to market changes brought about by rate cuts and carefully assess the risks and returns of various assets.

In summary, the Fed’s rate cut in September 2024 marks a new direction in global monetary policy. After the rate cut, capital generally flows to high-yielding stock and real estate markets, driving increased consumption and investment demand and thus promoting economic recovery. However, the market volatility and risks brought about by rate cuts cannot be ignored. For investors, understanding the logic and impact of rate cuts is key to making rational decisions.