Interest Rate Hikes 2023: How an Interest Rate Hike Affects Your Investments

You may have seen media headlines this past year about how interest rates have gone up again and how stocks are tumbling. The interest rate hikes that the Federal Reserve has been using to combat inflation have led to pain in the stock market.

If you’re an investor or interested in building a portfolio, it’s important to understand how rate hikes impact the stock market and your investments. 

Key Takeaways

• After the most recent rate hike by the Fed, we have now seen ten consecutive rate hikes since March 2022. 
• When interest rates go up, consumer demand decreases, which leads to companies reporting lower earnings. 
• When inflation is high, the cost of doing business increases for most companies. Investors become concerned about how stocks will perform in the future, so they start selling off their investments. 

The String of Rate Hikes

Whenever the Fed raises interest rates by 50 or 75 basis points, the stock market usually reacts negatively to the news immediately. For example, by the end of business on September 26, 2022 – a few days after the Fed raised rates by 75 basis points – the S&P 500 hit a closing low for 2022. The Dow Jones Industrial Average fell into a bear market. At that point last year, every U.S. stock market index was in a bear market as fears of a global recession loomed large. 

And since then, five more rate hikes have followed. The most recent rate increase happened earlier this month and marked the third consecutive rate hike of 25 basis points. 

Every rate hike in 2022 in 2023 immediately impacted the stock market. Let’s look at how interest rate hikes affect stocks and the logic behind this so that you better understand what’s happening right now. 

Why Did Interest Rates Rise Again?

Federal Reserve Chair Jerome Powell has made it clear since last year that the central bank will continue to raise rates until the battle against rising inflation is complete. Powell has said there is no painless way to fight inflation, though the Fed’s efforts are clearly having an impact, as inflation has dropped from its peak of 9.1% last June to under 5% in April 2023. 

As long as rate hikes continue, stocks could continue to tumble as the rest of the economy also slows down. Luckily, the Fed has signaled that its May rate increase may be the last rate hike we see in 2023. Further rate hikes would have likely led to further losses in the stock market for investors who have already had to deal with market volatility for over a year. 

Interest rate increases may stop for now as the balance in the economy is slowly restored. And while there was a point in 2022 when even Powell said a soft landing was unlikely, some experts now think it could happen. Other experts point to the first quarter’s shrinking real GDP growth as a signal a recession will be called later this year. 

How Do Interest Rate Hikes Affect Stocks? 

Whenever there’s an announcement of a rate hike, we should expect some volatility in the stock market. The most recent rate hike led to the S&P 500 dropping 0.7% at the market close. The DJI dropped 200 points or 0.8%. The tech-heavy Nasdaq Composite saw a dip of 0.46%. 

Still, this was a pretty mild drop compared to the hits the market took during the fall of last year. In September 2022 – the day the Fed announced a 75 basis point increase to the fed funds rate – all three of the above indexes dropped at least 1.7%. 

During that stock market drop, stocks in travel and entertainment fell the most. Of the 20 stocks in the S&P 500 that slid the most, 18 were a part of this sector since this is one area that gets hit particularly hard during an economic slowdown. Consumers are less likely to spend money on travel and entertainment – less essential commodities – when they fear a recession is looming. 

The Fed left its options open for June after the May announcement. It’s difficult to predict right now if rate cuts are in the cards soon. More bad news could be on the way as some experts continue to anticipate a recession. 

Why Do Interest Rate Hikes Affect Stocks? 

The Fed raises rates to cool down spiking inflation. Higher rates mean the economy won’t be as strong. But why is that? The fed funds rate impacts the rate at which banks borrow and lend each other money overnight. Banks must meet reserve requirements related to how much cash they keep on hand, so a higher fed funds rate encourages banks to save and borrow less. 

In response to a rate hike, banks will typically try to raise yields on savings products to incentivize consumers to deposit their money with the bank. They’ll also make short-term borrowing more expensive. 

Variable interest rates, like the rates for credit cards, move in tandem with the fed funds rate. This is another downward pressure on consumer discretionary spending. 

A rate hike is concerning news to investors because it typically signals companies will start to report lower earnings as…