Interest rate hikes would be detrimental to the economy – stock market, bonds, and mortgage loans prove.
Curry 23, (Ben is the Retirement and Investing Editor for Forbes Advisor. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for Bankrate and LendingTree) “What Happens When The Fed Raises Interest Rates?," Forbes Advisor, 6/21/23, https://www.forbes.com/advisor/investing/fed-raises-interest-rates/ // EE
Higher market interest rates can have a negative impact on the stock market. When Fed rate hikes make borrowing money more expensive, the cost of doing business rises for public (and private) companies. Over time, higher costs and less business could mean lower revenues and earnings for public firms, potentially impacting their growth rate and their stock values.
“If the cost of borrowing money from a bank increases, the opportunity to expand investment in capital goods by a corporation stalls,” says Dan Chan, a Silicon Valley investor and a former pre-IPO employee of PayPal. “The interest rate may be so high that many companies will not be able to afford to grow.”
More immediate is the impact Fed rate increases have on market psychology, or how investors feel about market conditions. When the FOMC announces a rate hike, traders might quickly sell off stocks and move into more defensive investments, without waiting for the long, complicated process of higher interest rates to work their way through the entire economy.
With Bonds, It Depends
Bonds are particularly sensitive to interest rate changes. When the Fed increases rates, the market prices of existing bonds immediately decline. That’s because new bonds will soon be coming onto the market offering investors higher interest rate payments.
To reflect the higher overall rates, existing bonds will decline in price to make their comparatively lower interest rate payments more appealing to investors.
“When prices in an economy rise, the central bank typically raises its target rate to cool down an overheating economy,” notes Chan. “Inflation also erodes the actual value of a bond’s face value, which is a particular concern for longer maturity debts.”
Mortgages and Home Loans Become More Expensive
Rising rates have an indirect impact on long-term home loans like a 30-year, fixed-rate mortgage. The rates charged for shorter-term loans with adjustable rates, like home equity lines of credit (HELOCs) and adjustable-rate mortgages (ARMs), rise immediately following Fed rate increases.
The rates banks charge for a 30-year, fixed-rate mortgage reference the yield on 10-year Treasury bonds. Typically the 10-year yield is more directly influenced by Fed rate policy, although the fed funds rate is only one factor among many that feed into 10-year yields.