In a situation that would have Sir Isaac Newton rolling in his grave, we’re disproving gravity: what went down (interest rates) must come back up. 

Low rates can help spur economic growth by making it cheaper for consumers and businesses to borrow money; conversely, higher rates can be used to cool off an economy that’s too hot. Rates were near zero to support the economy during the COVID-19 pandemic, but with today’s high inflation, the US Federal Reserve (Fed) is increasing rates in an attempt to stabilize prices.  

What Do Rates Have to Do With Inflation?

The Fed sets monetary policy to try to keep the economy humming along with full employment and stable prices. One item in its toolbox is the ability to adjust the federal funds rate, or the rate that banks borrow money from each other. This baseline rate influences interest rates on everything from mortgages and car loans to the interest earned on savings accounts or certificates of deposit (CDs). 

Today, with a growing economy and rapidly rising prices, the Fed can raise the federal funds rate to discourage spending by both consumers and companies, which should reduce demand and help rein in inflation. But raising rates will have some other ripple effects, too.

How Might Rising Rates Impact Me?

As with many things, how rising rates might impact you depends on your situation. Higher interest rates hurt borrowers since it makes it more expensive to take out loans, but tend to benefit savers since yields on savings accounts and CDs will eventually improve.  

For investors, equities that typically do well in a growing economy could be well positioned to withstand rising rates since the economy is in good shape. But since bonds have an inverse relationship with interest rates—as rates rise, bond prices fall—fixed-income investors are more likely to feel negative effects. Not all types of bonds will react the same way, but fixed-rate bonds with longer maturities are most sensitive to these changes (think US Treasury bonds). 

A Dose of Perspective

For context, the average federal funds rate since 1960 is just under 5%. It’s below that today, and the forecasted 4.0-4.5% by the end of 2023 would still be below average. In addition, the Fed has been forthcoming about its intentions, which gives investors time to work with their financial professionals to prepare their portfolios. Finally, bond and equity markets may react in the short term, but higher rates haven’t derailed market performance over the long term.