First, I’ll discuss how interest rate changes can affect bond investors.
When you invest in a bond that trades publicly, the price of the bond will move in the opposite direction of interest rates. If interest rates rise, bond prices fall, and conversely, when interest rates decline, bond prices go up. This means that if interest rates rise, you will see the value of bonds in your portfolio decrease. However, for investors who hold the bond to maturity, there is generally no need for concern. Despite short-term fluctuations in bond prices due to interest rate changes, bondholders will still receive the same fixed interest payments along with the bond’s face value at maturity. This assumes the bond issuer remains financially sound and can make interest payments on time and pay the full principal amount of the loan back to the lender at maturity.
Next, I’ll discuss how interest rate changes affect stock prices.
The relationship between interest rates and stock prices is more complex than the relationship between rates and bonds. Unlike bonds, stock prices do not have a direct mathematical relationship with interest rates. However, as a general principle, high interest rates should make stocks less valuable, and low interest should make them more valuable. This is because stock prices are based on investors’ expectations for future earnings discounted back to the present day. Higher interest rates increase the discount rate, making future earnings less valuable today.
That said, it doesn’t always work in the stock market, because stock prices are affected by many factors, including expectations for economic growth and corporate profit growth. For example, despite the Federal Reserve’s Federal Funds rate averaging around 0% in 2011, the S&P 500 index traded at a low valuation multiple of just over 12 times earnings. In contrast, in 2023, when the Federal Funds rate averaged a much higher rate of around 5%, the S&P 500’s valuation multiple exceeded 21 times earnings. This demonstrates that interest rates are not the only factor that determines stock prices.
Empirically, stock prices are more sensitive to rapid changes in interest rates than to the absolute level of rates. Historically, rapidly rising or falling rates have negatively impacted stock prices. While it’s clear why a rapid rise in interest rates would be troubling for stock prices, it’s less obvious why rapidly falling rates pressure stock prices. The reason for this is that rates usually fall sharply during periods of growing concern about deteriorating economic conditions. In contrast, small or gradual changes in interest rates have not typically been a problem for stocks.
Now, let’s look at how interest rates affect borrowers.
Higher interest rates are not always bad news; the impact depends on the type of loan held. For those with floating-rate loans or new borrowers, higher interest rates are undesirable because they increase the cost of borrowing. For those with floating-rate loans, including credit card debt, your interest payments will increase. For new borrowers, higher interest rates are undesirable because they increase the cost of borrowing for things such as car purchases or home mortgages. However, borrowers with fixed-rate loans may actually benefit from rising interest rates, particularly if those higher rates are due to stronger economic conditions. When interest rates rise due to economic growth, borrowers with low, fixed-rate loans, such as those who financed mortgages during the pandemic, may find that their income increases because of stronger economic and wage growth. This can make it easier to service their existing debt, despite the higher interest rates in the broader economy. Therefore, the relationship between interest rate changes and borrowers’ financial well-being is complex. While higher rates generally disadvantage those with variable-rate debt, they can provide unexpected benefits for borrowers with fixed-rate loans, especially in a growing economy.
Lastly, another item to mention quickly is that you’re likely impacted by rates in the form of the interest rate earned in your bank account. While a rise in rates may affect you negatively, as discussed above, if you’re looking to take out a mortgage or car loan, that same increase in rates might be positively impacting the interest rate that your bank is paying you to hold your money, either in the form of savings accounts, CDs, or other similar vehicles.
To summarize, interest rate changes impact both investors and borrowers.
Bonds typically lose value when rates rise, while stock prices are influenced by various factors, including interest rates and economic conditions. Borrowers with variable-rate loans face higher costs, but those with fixed-rate loans may benefit from rising rates if they are tied to stronger economic growth and higher wages. Therefore, despite what you may have read or heard elsewhere, higher interest rates are not necessarily bad news for consumers who hold both investments and loans.
Disclosures: The information provided in this presentation is for informational purposes only and should not be considered investment, tax, or legal advice. Howe and Rusling Wealth Management does not guarantee the accuracy or completeness of any statements made. All investments involve risk, including the possible loss of principal. Past performance is not indicative of future results. Any discussion of market trends or economic conditions is based on current information and is subject to change without notice. Investors should consider their individual financial situation, investment objectives, risk tolerance, and consult with a qualified financial professional before making any investment decisions. References to historical market performance or interest rate trends do not guarantee future results. Bond prices fluctuate, and holding bonds to maturity does not eliminate interest rate risk. Stocks are influenced by various factors beyond interest rates, including corporate earnings, market sentiment, and economic growth. Bank deposit products, including savings accounts and certificates of deposit (CDs), are generally FDIC-insured, but investment products, including bonds and stocks, are not FDIC-insured, not bank-guaranteed, and may lose value. Howe and Rusling Wealth Management is an SEC-registered investment adviser. Registration does not imply a certain level of skill or training.
