Federal Funds Rate: What Investors Should Know
The Federal Open Market Committee (FOMC) is holding its June meeting this week, and experts anticipate that the committee will pause on additional rate hikes for the first time in over a year. This is a departure from the ten consecutive rate hikes that have occurred since March 2022.
The federal funds rate is an interest rate set by the FOMC that represents the rate that banks charge other banks when lending each other money, usually overnight or for a few days. Financial institutions use this rate as a benchmark when setting rates on various lending products, savings account APYs, and more.
Federal Interest Rates & Their Impact
During times of high inflation, increasing the Federal Funds rate can help get the economy back on track. It can lead to an increase in other interest rates, slow down borrowing, and boost consumer saving. By decreasing the amount of money in circulation, it can boost the purchasing power of money and reduce the inflation rate.
The Fed’s adjustment of rates can impact the markets, creating uncertainty, and spooking investors as they’re not sure 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.
When interest rates are low, it creates liquidity in the economy, making it cheaper for companies to invest in themselves. For individuals, it makes it less expensive to borrow money to invest in securities. This liquidity pushes up the prices of stocks and bonds. Conversely, when interests rates increase, companies borrow less and have less to invest in themselves. Less corporate investment can lead to weaker earnings.
Alternative Investments During Federal Interest Rate Hikes
Cryptocurrency and other digital assets can be more speculative in nature, but these types of investments respond to changes in the federal funds rate and may even see a greater impact than more traditional assets. Investing in crypto can be a great way to diversify your portfolio, but it’s wise to limit your crypto exposure and keep it to a small percentage of your portfolio during times of uncertainty. When rates fluctuate, some investors might flock to “safe-haven” assets, which could impact the value of your investments.
Investor Strategies During Federal Interest Rates
Attempting to time the market and move accordingly could cost investors in the end. The best way to ride out short-term market bumpiness is to spread out risk across asset classes and ensure that financial houses are in order. It’s crucial to revisit investment strategies and ensure they align with goals and risk tolerance. Diversification can ensure that all investments aren’t in one basket. Rebalancing current asset mixes can ensure that portfolios remain aligned with goals.
The Fed’s adjustment of interest rates has attempted to curb rising inflation, and while it appears that FOMC is pausing on hikes, it’s impossible to guess how markets will react. Adjusting portfolios to align with personal preferences can make it easier to stay on course during uncertain times.