How the Fed’s Increased Interest Rates May Effect the Stock Market and your Bank Deposits

2022 and especially the last few weeks have been emotionally challenging.  The Russian invasion of Ukraine, inflation news, and the uncertainty of the economic affects of the Fed’s increased interest rates provides plenty of news that can cause uncertainty and fear for the near-term economic impacts.   Allow me to offer some historic facts that may provide a bit of calm to the apparent chaotic news.

For those of you too young to remember, inflation ran “hot” during the Nixon and Carter administrations ( 6.2% in ’73; 11% in ’74, between 9 & 7% in ’75 – ‘78; and finally 11.0%, 13.5%, & 10.3% in ’78 – ’81).   The public and markets at the time both had little faith that the Fed could contain inflation.  Previous threat to increase rates were pushed back on industry that felt higher rates would cripple economic growth.….that is until, Paul Volker was appointed Chairman of the Federal Reserve by President Jimmy Carter in August 1979.

Only two months after his appointment, Volker changed Fed policy from “easy credit” (like we have had for ten years) into very expensive credit.  Within two years, “the Prime Rate” that banks were charging their best- most-creditworthy customers was 21%.  In the early ‘80’s during the highest inflation, those of us buying homes remember the 13% to 16% mortgages.  Our grandparents loved the 14% CDs.  Business hated the 18 to 22% borrowing costs while credit card companies loved the 25% they charged on credit card balances. (1)

Finally, in 1982, inflation dropped to 6.2%,  to 3.2% in ’83 and finally to 1.9% in ’86. (2)  This was not an easy time financially.  It was painful.  But after a tough couple of years, the economy survived and thrived. (2)

“But what happened to my investment portfolio during this time?”

The S&P 500 was up 25.8% in ’80; down 9.73% in ’81; up 14.76% in ’82 and up 17.3% in ’83. (3)  All of this while the Fed increased interest rates to record levels.   

Bottom line.  The last six times the Fed tightened money monetary policy, the S&P 500 averaged going up 9.5%/ year. (2 & 4)  Yes, the S&P 500 is an index and you cannot invest directly in an index.  Historic returns are not indications or guarantees of the future.  However, much can be learned from history.  The take away here, in my opinion, is that increased interest rates will likely not kill the stock market.

Don’t expect inflation to go away very soon.   Many, many circumstances caused the inflation we are now experiencing so it may take a while to go back to a more reasonable level of inflation.  The Fed may need to increase rates 1.5 to 2.0% over the next year.  These increases will continue to create volatility both up and down in market indexes.  Don’t lose faith that markets will recover and go even higher than the previous high marks.

Will the banks start paying me higher interest on my saving deposits because the Fed has increased interest by 0.75% so far this year?  

Eventually….but not right way.  Banks will only increase rates if they have to in order to attract more deposits.   Banks make money on the interest spread between the interest charged to borrowers verses the interest they pay depositors.  When loan demand is high or cash reserves are in short supply, banks will need to attract more deposits by paying higher interest.  However, at this time banks are flush with cash so they have no incentive to pay higher interest and attract more deposits.  Therefore, it could take many months before banks need to or are willing to pay you higher interest for your deposits.

Bottom line, I would encourage to stay invested and if possible, invest more when the markets are down.  Call me and we can talk further.

Wollman Wealth Design, Inc is a financial planning and investment advisory firm in Escondido, CA that partners with people in San Diego County, California and the rest of the country who are striving to identify financial priorities and design a reasonable approach to accomplishing their financial goals.  Please contact us with questions, comments, or to schedule a phone call or a Zoom or an in-person office meeting.

1. https://www.stlouisfed.org/publications/regional-economist/january-2005/volckers-handling-of-the-great-inflation-taught-us-much
2. https://www.usinflationcalculator.com/inflation/historical-inflation-rates/
3. https://www.macrotrends.net/2526/sp-500-historical-annual-returns
4. https://insight.factset.com/sp-500-earnings-season-update-may-6-2022

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"The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein.  Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed.  Past performance does not guarantee future results.

Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.