How Do Higher Interest Rates Impact The Stock Market?
What Is The Federal Funds Rate?
Let's talk about interest rates...
The Federal Reserve is responsible for setting the Federal Funds Rate.
Which is the interest rate that big banks charge each other to borrow and lend money.
And those rates trickle down to the rest of the lending world.
Mortgage, credit card, and auto loan interest rates change based on the Federal Funds Rate.
You can think of the Federal Funds Rate as the "economic gravity" force.
The rate essentially controls how much it costs to borrow money.
The lower the Federal Funds Rate is... the cheaper it will be to borrow money.
The higher the Federal Funds Rate is... the more expensive it will be to borrow money.
The Federal Reserve generally lowers the Federal Funds Rate during recessionary periods to make money cheaper to borrow and incentivize people to take out loans and spend money in the economy.
When the economy gets too hot...
And inflation becomes a threat to economic stability...
The Federal Reserve will generally hit the breaks and increase the Federal Funds Rate to make money more expensive to borrow and incentivize people to slow down spending and save cash.
The companies (or people) who overextended themselves during the times of cheap debt will normally get hit the hardest when the Federal Reserve hits the breaks and increases interest rates.
Federal Interest Rate History
Here’s a chart that shows the history of the Federal Funds Rate going all the way back to the 1950s.
You’ll notice that in recent years... the Fed Funds Rate has been stuck at practically zero... following the Great Recession of 2008.
This is why we've seen record low interest rates over the past decade.
How Higher Interest Rates Impact Assets
The Federal Reserve increases interest rates to cool down the economy.
High-Interest rates make borrowing money for companies (and people) more expensive.
Naturally... companies that aren't profitable will struggle the most. Primarily since they rely on borrowing money to continue their operations.
All assets are impacted by higher interest rates one way or another...
REAL ESTATE: Higher interest rates decrease the amount of money buyers can borrow from banks. Killing buyer demand.
STOCKS: Higher interest rates make it more expensive for companies to borrow money and can decrease future consumer demand.
BONDS: Bond prices have an inverse relationship with interest rates. This means that when interest rates go up, bond prices go down, and when interest rates go down, bond prices go up.
CRYPTO: The riskiest assets get hit the hardest. Investors tend to take less risk when money isn't flowing freely throughout the economy.
To sum it all up: the riskier the asset - the more likely it is to get negatively impacted by higher interest rates.
Looking Forward...
Higher interest rates have caused the market to take a nosedive in 2022.
The problem is... nobody knows how high the Federal Reserve will continue to take interest rates.
Many investors expect interest rates to continue to rise throughout the rest of 2022... and much of that seems to be already priced into the stock market.
But all it takes is one announcement from the Fed to change those expectations.
So it's more or less a guessing game...
Will the stock market continue to fall lower?
Well... as you might guess... no one knows for sure.
There are many factors involved when it comes to the stock market.
One thing to keep in mind: Future millionaires are made (or destroyed) in bear markets.
What you do (or don't do) in bear markets determines your financial future.
Just like bull markets eventually become overly optimistic.
Bear markets eventually become excessively pessimistic.
But that pessimism creates excellent investment opportunities for long-term investors who continue to buy stocks on sale... Despite all of the short-term fear in the market.
So unless you are a few years away from retirement: Any stock market decline should be seen as a gift to buy more on sale.
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As Always: Buy things that pay you to own them.
-Josh
Blog Post: #045
