Over the better part of the past 12 months we’ve spoken quite a bit about the impacts that interest rates have on the overall economy asset valuations and honestly just investor sentiment. Overall which realistically shouldn’t be that much of a surprise as we’ve seen firsthand the impact that low interest rates have on the stock. as well as the real estate market over the past two years and you know this comes at a time when inflation is at the highest level that we’ve seen since the 80s right as we can see from this chart average inflation across the us has reached 7.9%. which yeah i had mentioned in a previous Article that i absolutely believed we continue seeing inflation rise past the 7.5 percent that we saw in january and realistically this figure could continue to rise and stay at very high levels over the course of 2022. which is very difficult for everyday consumers so at this point though let’s consider that the federal reserve really doesn’t have any other option than to start raising interest rates gradually in order to try and tame this out of control level of inflation while also avoiding completely halting economic growth across the american economy now…
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What can FED do?
After months of anticipation towards the fed actually raising interest rates over time. Well now it is actually commenced where the american federal reserve has indeed approved the first interest rate hike. Now more than three years december 2018 to be exact and this is really significant because increased interest rates do have direct impacts on the economy as well as the markets. Just like we’ve seen the opposite of over the past two years when rates were near zero so yeah as we can see here since march 2020 the fed dropped down rates to 0.25 percent in order to stimulate economic growth in the face of the pandemic and it stayed there for the better part of two years until this past week, where the FED approved a point two five percent rate hike which now sits at point five percent now a point two five percent interest rate hike you might be asking yourself what exactly does this mean for everyday individuals and investors.
well quite simply this has a direct impact on the prime rate that banks and other lenders are going to use in order to issue out consumer loans so typically say a bank is going to issue out a personal line of credit at the prime rate plus a certain percentage for the borrower’s total rate so this basically means that over the next couple of years it’s gonna get more expensive to borrow money for all purposes from credit cards personal lines of credit mortgage and so forth now this point five percent interest rate hike isn’t much in the big picture but let’s consider that the fed can’t just simply uh raise interest rates by one percent out of the blue this would totally destabilize the market so it’s somewhat of a balance and also a stable increment over time however it is expected that we’ll be seeing six more rate increases by the end of the year bringing the consensus funds rate to 1.9 percent and for now the fed also expects three more rate hikes in 2023 and none the following year meaning that by the end of this entire rate hike cycle we should be seeing rates at around 2.5 percent which would put us at around the same rates that we experienced just before the pandemic but really that’s just a guess and if inflation does continue to rise rapidly it really wouldn’t be out of the question if we see the fed increasing rates at a quicker pace but then also by larger increments at a time based on reasons that we’ll be discussing shortly even though this could definitely have a shock on the financial system the question really though is will these interest rate increases be enough to materially counter the high levels of inflation that we’re experiencing while also allowing though for continued economic and gdp growth which of course we do want to continue seeing well historically speaking the fed tends to lower interest rates in order to further stimulate economic growth as lowered financing costs tends to encourage further borrowing and investing but what ends up happening is that when the rates get too low as we’ve experienced over the past two years well this can very well lead to excessive growth and well subsequent inflation which reduces purchasing power and undermines the actual sustainability of the economic expansion in question i mean at the end of the day inflation aside let’s not forget the insane level of asset growth that we’ve experienced in both the stock market as well as the real estate market since the march 2020 lows the s p 500 expanded by over a hundred percent and many markets added 30 to 70 value to their real estate which is almost never before seen in such a short period of time so essentially when it’s cheaper to borrow not only do consumers utilize more debt but so do businesses in order to further fuel their own growth and expansion which really just creates an environment of larger output and productivity on the flip side when it’s more expensive to borrow which is the reality that we’re going to be faced with over the foreseeable future well this leads to consumers purchasing less goods and services and so demand tends to end up dropping which should have an impact on decreased inflation one of the most striking examples of this was back in the early 80s where inflation was at 14 and the fed raised interest rates to 19 which caused a severe recession but it did end up putting an end to the crazy inflation that the us was seeing so all this to say that with interest rates on the rise over at least the next two years we should expect this to yes have an impact on taming inflation but then also decreasing economic growth pretty much across the board..
Interest Rates and the Markets
how this can impact the stock market right we’re investors here and with interest rate hikes impacting the economy well this is going to undoubtedly ripple over into the stock market in fact we’ve already been seeing this with investors already pricing in these expected rate increases ahead of time that’s definitely something that is interesting about the stock market sentiment and overall investor emotion can lead to upwards and downwards movements in the broad market and individual positions so even though we have been seeing the broad market bounce back over the past week or so this definitely does not mean that the bleeding has fully come to an end at the end of the day it’s easy to forget that the stock market is made up of actual businesses that operate in the economy and many of these businesses utilize debt capital to further expand and grow so of course an increased cost of borrowing also negatively impacts the bottom line of many companies especially unprofitable companies to begin with now that being said the fed actually expects business growth will continue to slow down for the rest of the year at around 2.8 percent which happens to be down from the prior forecast of 4 growth so really even though it’s already been extremely rough over the past year or so for many tech and smaller cap companies that are unprofitable and also utilize a lot of debt capital to fuel their growth well i kind of think that this is going to continue unraveling over the foreseeable future at least until we’re seeing these interest rate hikes stabilize in the market right because even though the market has already started pricing in these rate hikes over the past couple of months before it even started happening well if the fed decides to increase the rates at a much quicker pace or by larger increments this could absolutely have a destabilization effect on the market of driving it down further now that being said does this mean that you shouldn’t continue investing in the stock market over the course of this year and next no not at all always remember that it’s completely normal to see periods of slowed economic growth and valuation growth throughout the course of a long-term investment approach granted that the funds and your asset allocation are suitable to your investor profile as well as your risk tolerance i’m simply going to continue doing what i’ve been speaking about for years on the channel and doing myself as an investor being the older cost averaging into broad market low cost index funds that allow me to average into the market and ride the growth of the american economy over years to come now what about the impacts on the real estate market right i’ve been speaking a lot more about real estate investing on the channel because it’s something i’ve been doing a lot more of in real life and i’ve also been speaking about it a lot on my tech talk make sure to follow me there if you don’t already posting it daily multiple different clips about questions people have as well as other topics about real estate investing and just investing in general really well i’m not going to dive into all the details around what impacts the real estate market but of course interest rates does have an impact on this somewhat right if you want to learn more about my thoughts around the real estate market and how raising interest rates could potentially have an impact on lord or at least stabilizing the real estate market over the next couple of years make sure to check out the video that i’m going to be overlaying right here now the bottom line is that as investors we should absolutely be expecting the markets to be somewhat choppy over the next year or two as all of these factors are tugging at the market and trying to be priced in especially following such a large market rally that we saw over the course of last year so make sure to leave me a comment down below letting me know how you think these interest rate hikes are going to impact the stock market and the overall economy this year.