Why the stock market hates the idea of rising interest rates

On Jan 27, 2022

Traders work on the floor of the New York Stock Exchange at the opening bell Jan. 25, 2022.

TIMOTHY A. CLARY | AFP | Getty Images

The specter of rising interest rates is spooking the stock market.

The Federal Reserve, the U.S. central bank, is expected to increase its benchmark rate several times this year to tame stubbornly high inflation. Fed chair Jerome Powell affirmed that likelihood on Wednesday.

The move would increase borrowing costs from near zero — where they’ve been since the beginning of the Covid pandemic — for businesses and consumers.

The forecast has caused stocks to nosedive in January.

The S&P 500 index is down about 9% for the year. At one point this week, the basket of U.S. stocks dipped below 10% — the first time that’s happened since the initial pandemic turmoil of March 2020. The index closed down 0.2% Wednesday after Powell’s remarks, erasing earlier gains.

Cooler economy

Why does the stock market care?

Broadly, the reasons seem to be twofold: A slowdown of the U.S. economy and the prospect of other investments like bonds becoming more attractive relative to stocks.

When the Fed raises its benchmark interest rate, banks and lenders tend to raise borrowing costs, too. Mortgages, credit cards and other debt become pricier, reducing consumer spending and demand. Businesses also pay more to finance their operations.

Broadly, this dampens the outlook for company profits and reduces investor enthusiasm for buying their stock.

“A tightening of monetary policy will put pressure on economic activity,” according to Blair duQuesnay, a certified financial planner and investment advisor at Ritholtz Wealth Management, who’s based in New Orleans. “And it’s by design.”

Too far, too fast?

The Fed’s “design” is to cool off inflation. Consumer prices jumped 7% in December from a year earlier, the fastest pace since 1982.

But the stock market isn’t reacting just to a likely rate bump; stock gyrations have as much to do with uncertainty over how fast the Fed will accelerate.

“What the market doesn’t like, is rapid changes in the monetary landscape,” according to David Stubbs, the global head of cross-asset thematic strategy at J.P. Morgan Private Bank.

When inflation began accelerating in early 2021, Fed officials signaled it was likely temporary, the short-term result of a hyperactive economy emerging from its pandemic hibernation.

Now, their tone has shifted as inflation has lingered well above the Fed’s 2% long-run target. In large part, that seems due to consumer demand for physical goods outstripping supply, as Covid continues to disrupt manufacturers.

“Since the December meeting, I would say that the inflation situation is about the same but probably slightly worse,” Powell said Wednesday. “I think to the extent the situation deteriorates further,…