How the federal funds rate impacts your investments
The Federal Open Market Committee (FOMC) is set to meet this week for its June meeting and many experts anticipate that for the first time in over a year, the committee will hit pause on additional rate hikes for the time being. This is a departure from the ten consecutive rate hikes that have taken place since March, 2022.
Many are anxiously awaiting the Fed’s next move because of the impact that this rate can have on savings accounts, credit cards, mortgage rates, and even your investments.
Where the federal funds rate stands today
In short, the federal funds rate is an interest rate, set by the FOMC. This rate represents the rate that banks charge other banks when they lend one another money, usually overnight or for a few days.
While the federal funds rate doesn’t determine specific rates on consumer products, financial institutions use it as a benchmark when setting rates on various lending products, savings account APYs, and more.
Why does the Fed adjust this rate so frequently? Well, during times of high inflation, it can help get the economy back on track. Increasing the Federal Funds rate can lead to an increase in other interest rates, slow down borrowing and boost consumer saving. Reducing the amount of money in circulation will help boost the purchasing power of your money and reduce the inflation rate.
Here’s a look at how rates have changed this year:
How fed rate hikes impact businesses and investors
When the Fed adjusts rates, it can create turmoil in the markets—primarily because no one knows with certainty which moves the Fed will make next and how it can impact the asset classes they’ve invested in.
Depending on the direction in which rates move, markets can respond differently and investors can become easily spooked.
“When rates are low, money is cheap creating a lot of liquidity in the economy. Companies and people are willing to borrow more. This makes it cheaper for companies to invest in themselves. For individuals, this makes it cheaper for them to borrow money to invest in securities. This adds more liquidity to the markets and more money coming into the markets pushes up the prices of stocks and bonds, says Anthony Denier, CEO of Webull, a commission-free trading platform.
When interest rates increase, the opposite is true.
“Companies borrow less and have less to invest in themselves. Less corporate investment can lead to weaker earnings. Meanwhile bond yields rise with interest rates making them more competitive to the value of future corporate earnings. Stocks, which are riskier assets than bonds and based on corporate earnings, become less competitive when bond yields move higher.”
Alternative investments aren’t immune to the impacts of rate hikes
Cryptocurrency and other digital assets may function differently and be more speculative in nature, but experts say that these types of investments respond to changes in the federal funds rate and may even see a greater impact than more traditional assets.
While investing in crypto can be a great way to diversify your portfolio, you may want to limit your crypto exposure and keep it to a small percentage of your portfolio to avoid major dips in performance during times of uncertainty.
When rates fluctuate, some investors might flock to “safe-haven” assets, which could impact the value of your investments.
“Higher rate environments like we saw in 2022 and this year typically see investors reallocate their portfolios to safer assets like treasuries or money market funds that can actually generate higher (due to interest rate increases) and more stable returns,” says Wes Moss, managing partner and chief investment strategist of Capital Investment Advisors in Atlanta, Georgia.
What can investors do in the meantime?
When it comes to your investments, experts say it’s always best to play the long game. Attempting to time the market and move accordingly could cost you in the end. The best way to ride out short-term market bumpiness is to spread out your risk across asset classes and ensure that your financial house is in order.
If you haven’t rebalanced your portfolio in a while, it may be time to revisit your current asset mix to ensure that your portfolio still aligns with your goals and risk tolerance.
“Investors should focus on diversification across and within asset classes to ensure all of their eggs aren’t in one basket,” says Moss. “You should also revisit your investment strategy and ensure that strategy aligns with your near, intermediate, and long-term goals. This can take the shape of making sure funds earmarked for a house down payment are stored in cash or other highly liquid, safer investments rather than equities or other more volatile asset classes.”
The takeaway
Over the past year, the Fed has made several attempts to curb rising inflation through federal interest rate hikes. While it looks like the FOMC could hit pause on rate hikes for the time being, there’s no telling how markets will respond. In the meantime, taking stock of your current asset mix and adjusting it to align with your personal preferences can make it easier to stay the course.