How Recent Rate Hikes Could Affect Your Investments

interest rate graph on tablet

The Fed raised the Fed Funds by 25 basis points in March, just three months after a rate hike in December. The last previous raise was in December the year before. And now the markets expect to see at least two more hikes before the end of 2017.

Originally, the rate hike discussion kept getting delayed because the economy wasn’t producing the kind of data the Fed was looking for, so this sudden shift in gears should have a big impact on the economy. With multiple hikes on the table for this year alone, investors need to be prepared for a more volatile market.

The Effect of Interest Rates on Stocks

Over a long period of time, it’s hard to say what the full impact of higher interest rates has on the stock market. Interest rate hikes won’t prevent stocks from going up, but that effect happens over a period of years. In the short term though, rate increases tend to have a detrimental impact on stocks.

As rates climb, interest on debt also goes up, making it more expensive for companies to take out loans and do business. Debt obligations and interest payments go up, which in turn curbs business activity and helps to slow down the economy. This is done in an effort to curb inflation and keep the economy balanced.

A slow increase in interest rates doesn’t have much of an impact. This is because the slow increase gives investors and companies plenty of time to adapt to the new paradigm without sacrificing much in the way of earnings. But if rates rise rapidly, then it could become difficult for companies to take into account higher debt payments and procure loans. That means lower earnings and lower stock prices.

In July of 2016, inflation was a mild 0.8 percent. As of February, inflation has risen to 2.7 percent – a gain of more than 200 percent in less than a year. The quick jump in inflation is primarily why the Fed changed their timetable. If the hike in rates is successful, inflation should decelerate, keeping the economy in balance.

One concern over this speed is how quickly the rates will actually impact inflation. As it stands, the boost in rates will only affect debt assets and won’t actually help out savers with rats on savings accounts. It may be some time before savers will see the benefits of higher rates.

Is There Anything You Should Do?

Investors should use caution as the Fed enters into a faster cycle of rate hikes. If stocks continue to climb at the same pace they have been, valuation multiples will increase along with volatility leading to irrational pricing. A sudden correction could occur, leaving investors scurrying to find an exit. The resulting sell-off could trigger an even greater correction or lead to a full bear market that wouldn’t bottom out until stocks are properly priced in with the new interest rate.