Rising Interest Rates Flow to Economy, Stock Market, and Ultimately Consumers

Chart of the Week for September 10-16, 1999

Changing interest rates do not just affect your retirement portfolio returns, they affect your way of life. Recently, the Federal Reserve has raised rates to slow the economy and prevent any inflationary pressures. As interest rates rise, borrowing costs for everyone increase. Not only will you pay a higher rate on your credit card debt, but companies will be incurring unexpected higher expenses. These higher costs can find their way to back to the consumer through higher prices on goods and services. As sales decrease through increased prices, the economy slows and the Federal Reserve meets its intended goal.

When the Federal Reserve changes or even contemplates changing interest rates, one of the first ripple effects is felt on Wall Street. Two sectors in particular that are interest rate-sensitive are financial stocks (like banks and insurance companies) and consumer cyclical stocks (like autos and equipment makers). Over the two months ending August 31st, the S&P 500 returned negative 3.8% as interest rates inched higher. In response to higher rates, financial stocks and consumer cyclicals were off 10.8% and 10.0% respectively over the same time period.

Although not as immediate, one example of how changing interest rates affect the economy can be seen in housing starts. As the chart above depicts, it is clear that when interest rates (and corresponding mortgage rates) are low, housing starts are high. Most recently we have been seeing housing starts decline due to higher mortgage rates. This is just one example of how changing interest rates can affect your current lifestyle and/or future plans.

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