Interest rates have been in the news plenty over the last couple of years and that’s not likely to change any time soon. And while they play a pivotal role in shaping the economic landscape and influencing investment decisions, investors don’t always understand the dynamics of interest rate movements and how they can impact various asset classes. I’ve had plenty of clients asking me about these dynamics recently, so I thought I’d share my perspective.
The Basics of Interest Rates:
Interest rates are set by central banks and determine the cost of borrowing money, for individuals and for businesses. They are also a key tool used to manage inflation. (This is what we’ve all been hearing so much about.) Understanding how interest rates are set and the factors that influence them are key components to understanding the market landscape.
Bond Market Reactions1:
Bonds and interest rates are inversely correlated. If one is high, we usually expect to see the other go lower. There are a variety of reasons why this is true, but the important thing to remember is that it is important for you and your advisor to assess your bond portfolio when interest rates move in an effort to mitigate risk.
Impact on Stock Prices2:
Interest rates typically influence stock prices as well. When interest rates rise, it becomes more expensive for companies to borrow money, which can have an impact on a company’s bottom line. The general exception to the rule is the financial sector, which tends not to be negatively impacted by higher interest rates. As you review your portfolio with your advisor, it is helpful to talk through sector-specific implications against the backdrop of changing interest rates.
Real Estate Dynamics3:
Unsurprisingly, the real estate market is incredibly sensitive to interest rate changes. This matters to property owners and investors alike, though for different reasons. When money becomes more expensive to borrow, this can cool the real estate sector as people decide to stay in homes with lower rates or put off a home purchase all together. And when interest rates go down, that can have a stimulating effect on the housing market, typically increasing demand. For investors, it is important to understand your exposure to this sector and discuss with your advisor how interest rate fluctuations will impact this part of your portfolio.
Interest rate movements will continue to be top of mind for investors in 2024. Being aware of how changes in interest rates can impact different asset classes can be helpful when making investment decisions.
Have more questions about the current state of interest rates? Talk to a Beirne advisor today. Click here to contact us.
1 "Inverse Relation Between Interest Rates and Bond Prices," by Nick Lioudis, March 28, 2023
2 "How Interest Rates Affect the U.S. Markets," by Chris Seabury, December 20, 2023
3 "How Interest Rates Affect Property Values," by Troy Segal, May 11, 2022