A rise in interest rates — like the one the Federal Reserve recently announced – makes borrowing more expensive. It also may encourage people to save more, which slows excessive spending characterized by inflation. As a result, the economy typically slows when interest rates rise.
The Federal Open Market Committee, the Fed’s policymaking arm, has been pondering how much and how quickly to raise rates. Some investors believe it needs to move faster. The Fed’s new “dot plot” suggests a rate near 3.5% by the end of 2022 and close to 4% in 2023.
Consumers may feel the effects of higher rates on existing debt, including car loans, home mortgages and credit card balances. The increase in interest rates can also impact the prices of imported goods, which are often priced in dollars. This can hurt companies that sell internationally, or at least reduce their profits in terms of foreign currency.
Higher rates can boost the profitability of banks, which can earn more money on the dollars they lend out. This tends to be good for bank stocks, but bad news for companies that borrow heavily abroad. The rising dollar – bolstered by higher interest rates – can hit companies that do a lot of business in foreign markets, including Johnson&Johnson, Microsoft, Hershey and Caterpillar.
For investors whose portfolios are heavier in bonds, such as those nearing retirement, a rate hike can mean less income. It’s a good idea to work with a financial advisor to see how these changes might impact your strategy.