How Increased Interest Rates May Affect Consumers
Whenever the Fed makes a move, it's always shrouded in a lot of media coverage which can incite fear and cause general anxiety. In the past few months, the media has been dominated by talks of when the Fed will begin tapering, or reducing the amount of assets they are buying in order to scale back on the economic relief they have been pushing since the start of 2020 to cushion the economic impact of COVID-19. The most recent updates suggest they will begin this process in 2022. Tapering will increase interest rates, which sounds like an unequivocally bad thing. In reality, it is, like most things, a mixed bag. The perpetual media buzz about the Fed's tapering timeline has created a dark cloud that looms over the markets like a threat. Of course tapering will affect the markets, but it’s important for the average investor to have an understanding of how increased interest rates affect consumers and the economy. Knowledge about how this kind of tapering has influenced markets historically can act like the sun, breaking through the dark threatening cloud created in the news and casting light on the truth of these market events instead.
How Increased Interest Rates Affect Businesses, Borrowing, & Spending
The Fed sets the prime interest rate, or the federal funds rate, which is the rate that banks pay to borrow money from the Federal Reserve. In other words, they decide how much it costs for banks to borrow money, and banks in turn pass this cost on to their own borrowers. In 2008, the Fed set its interest rate close to zero to bolster the economy, essentially giving out “free money”. By making money less expensive to obtain, reducing the Federal funds rate created an increased supply of money. Businesses could borrow more money and invest in their businesses and hiring as a result. This increased the employment rate which increased consumer spending, and as more people purchased goods, services, houses, and stocks, the economy was booming again. Conversely, increasing the Federal funds rate reduces the supply of money, because it makes money more expensive to obtain. This reduces inflation by decreasing the amount that consumers and businesses are spending. When the Fed does increase their interest rates, it will increase the expense on banks to borrow money. This means that banks will increase the rates they charge individuals to borrow money by raising credit card and mortgage interest rates. Consumers therefore will have less money to spend, and less loans will be secured by individuals. While this does reduce inflation, it will also mean that businesses pay more to borrow money, which will decrease business spending and hiring. This leads to consumers having less disposable income, and thus business revenue is negatively impacted, as people stop spending so much money on consumer items.
How Increased Interest Rates Affect Stocks, Bonds, Commodities, & Debt
The stock market is affected because as investors see companies make less profit and reduce growth spending, stock prices decrease. Some investors will turn away from stocks and turn towards the bond market, which they view as a safer more secure investment. This leads to an increase in bond interest rates. Global stocks, however, likely increase in value when the interest rates rise, because the dollar appreciates. When the dollar is stronger it means that US consumers pay less for imports. This creates an increased demand for products from Asia and Europe, increasing profits internationally and subsequently increasing the price of global stocks. A stronger dollar also contributes to the reduction of prices of commodities. The US government has a lot of debt, and increased interest rates contribute to higher interest payments. This is also true for corporations that are repaying loans and mortgage holders that do not have a fixed interest rate.
Just One of Many Factors
None of these chain reactions are necessarily bad or good - but they are important factors to consider when crafting your own investment strategy. The Federal funds rate is also only one of many factors to consider - there are many trends, news events, and other things that affect the market and its different sectors. In an investment strategy, it’s important not to focus too much on the one thing that’s dominating the news cycle, instead maintaining a broad, multi-faceted view. At NEST, we rely on data received and analyzed weekly to inform how we actively manage our portfolios to anticipate the effects of things such as the Federal interest rate in conjunction with a variety of other factors. Email the partners directly at info@nestfinancial.net to schedule a no-obligation consultation and learn more about our actively managed portfolios and process so that your investments are resilient no matter when the Fed decides to start tapering. Find us on:LinkedIn Facebook Yelp TwitterDISCLAIMER: We are legally obligated to remind you that the information and opinions shared in this article are for educational purposes only and are not financial planning or investment advice. For guidance about your unique goals, drop us a line at info@nestfinancial.net.