So, What Happens if the Fed Raises Interest Rates?

This Thursday, the Federal Reserve Bank (aka ‘The Fed’) will hold a meeting that has the financial world holding their breath, and it may have an affect on you. So we’re going to take a second to give you the scoop.

The Scoop: 

The Fed is hosting a pow-wow on Thursday to decide if it should raise interest rates. If the Fed raises rates, it will become more expensive to borrow money (for both real people like us and for companies). More expensive to borrow money = less borrowing of money and higher interest rates on outstanding loans =  declining growth & profits for companies.  If there’s a rate hike, you’d be safe to expect stock prices to slump.

Now on to what all of that means:

The Fed has kept interest rates low to stimulate the economy. After the devastation of the 2006-2009 downturn, the economy needed all the help it could get. Low rates spur spending because low rates mean cheap borrowing costs. This helped anybody with a loan: home buyers, car buyers, students, the federal government (by far the largest single borrower) and companies (who borrow to expand their businesses).

The fed now sees that the economy is in relatively good shape. So it may be time to ease interest rates back up (keeping interest rates low for too long can create “bubbles” that can be painful when they pop).

So, what happens when The Fed raises interest rates?

The most immediate impact is that it becomes more expensive to borrow money. If you have a variable rate mortgage, you will understand the impact. And if you shop for a new car loan, you will also feel the impact.

As an investor, there are some extra issues you need to know about.

Companies are big borrowers. Most often they borrow to expand their businesses. If interest rates go up, expansion becomes more expensive. Also, if they already have loans, they may reset at higher interest rates. So higher interest rates can sap both growth and profit.

Investors hate this! Anything that hits the profit or growth of a company can impact the price of a stock as investors reevaluate the value of a slower growing, less profitable company.

Higher interest rates can also slow consumer spending as more money comes out of our pockets to pay higher interest on our loans and mortgages. This will also hit the bottom line of companies.

So, as you can see, higher interest rates can hit stock prices from both sides.

So if the fed raises interest rates, watch for stocks to slump, especially if they hint that this is only the beginning…

As a side note, higher interest rates will also affect the government. More tax dollars will have to be spent on interest payments, leaving less available for programs. So watch for an increase in the volume and noise about government debt and deficits.

On the bright side, if you are the one lending money, you will earn more interest. This is true for bank deposits (your trusty savings account) and for bonds. Both should offer slightly higher interest rates!

So we hope this helps put perspective into what the Federal Reserve may do. As of now, the market sees a 25% chance of a rate hike. So the market, on average, does not expect rates to rise. A rise will be unexpected, especially if it is more than .25%. And stock prices are really based on expectation… So expect the market to drop with a rate hike, especially if it is more than .25%.

In the meantime, remember everyone starts somewhere, and sometimes, volatile times can be a great time to learn.

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