I recently read an article in the New York Times and observed the authors raising a point that the stock market has become increasingly concerned about in recent weeks, namely that the period of low interest and inflation rates may be coming to an end. If this is true, what impacts are likely to be felt by investors and consumers, and what actions should you take to protect your future?
First, the two issues are not unrelated — the Federal Reserve has been raising the Federal Funds rate (the interest rate they control and the rate upon which all other interest rates are based) consistently over the last 18 months, both to gradually withdraw their involvement in and support of the credit markets and as a means of getting the inflation rate nearer their target rate of 2 percent per year. So, increasing interest rates cause the inflation rate to rise; therefore, the fact that they are both increasing is not unexpected — it is planned.
Second, the stock market generally regards increasing rates negatively because higher interest rates dampen consumer spending (homes, cars, furniture, credit cards); higher inflation rates cause more money to be spent on necessities, leaving less for discretionary spending; and higher interest rates make fixed income investments more attractive relative to stocks. So, don’t expect the stock market to react positively to this trend.
Third, higher interest and inflation rates means consumers will have less to spend because the cost of things is going up, as is the cost to finance purchases. This in turn can have a dampening effect on our economy as consumer spending slows, resulting in smaller corporate profits, leading to lower stock prices.
As with any change, the key here is balance — finding the right position on the teeter-totter (remember the teeter-totter you once played on?) between rates that are high enough to cause wage inflation, which spurs growth, but not at the expense of killing consumer spending. The Fed works hard at achieving this balance, but they don’t control all of the puzzle pieces. So, in the meantime, you can try to keep an allocation between equities and fixed income in your investments, or use an algorithm, which will protect your downside, whether they are in an IRA, 401(k) or other plan. As always, working with an independent advisor who acts as a fiduciary is one way to stay on track and help achieve both the safety and peace of mind you seek.