How High Could Interest Rates Get?
Unless you’ve been living under a rock, you’ve probably noticed that interest rates on the rise again. It’s been years since investors had to be concerned about interest rates when choosing investments, and some may be out of practice. But concerns are floating around on Wall Street about what rates might do next.
At first glance, higher rates might lead one to think that stocks will go down. After all, with higher rates comes higher interest payments on debt obligations – something essential for financing day-to-day business operations. But in practice, the markets don’t behave so predictably. In fact, it’s often the unseen tertiary effects of higher rates that impact stocks more so than the actual increase in rates themselves.
Catalysts to watch out for
There are a number of factors investors need to keep a close eye on in regards to where interest rates are heading. While the usual suspects like inflation and GDP will play the largest role in determining how far interest rates rise, there are other considerations at play.
A healthy economy is a balanced one. Inflation around 2%, unemployment near 3.5%, and a GDP that clearly sends a message of strength, but not so high as to induce fears of overheating. If these conditions are met, then interest rates themselves won’t really matter. But the markets rarely stay at such levels.
Inflation can be difficult to control or predict, and interest rates are the primary tool used to combat too-high or too-low inflation data. Inflation tends to hurt the value of the dollar and erode its value as a standard of currency. But rising interest rates to combat inflation can also mean higher demand for the dollar.
Looking ahead to the next twelve months, the value of the dollar will likely play one of the biggest tell-tale signs in determining whether or not higher rates are a good or bad thing. In the late 1970’s inflation began to rise, and interest rates along with it, until they hit well over double digits. But the subsequent boom of the 80’s led well into the decade after, with growth catching up to inflation and interest rates, balancing the economy out once again.
One important note investors should keep in mind is that interest rates by themselves don’t actually have much of an impact on the stock market as a whole. Certain industries like financials tend to benefit from higher rates, but the market seems to be able to absorb the impact of higher rates quite well.
It’s the speed at which interest rates rise that becomes a problem for companies to manage. As long as the Fed keeps interest rate increases at a reasonable pace, stocks shouldn’t see a noticeable dip in performance. In the long term, the actual level of interest rates won’t matter very much. While investors shouldn’t completely ignore what interest rates are doing, avoiding panicked decisions based on rate changes is key to maintaining profits in your portfolio.