How To Invest If The Fed Keeps Raising Interest Rates

Key takeaways

• The Fed have increased the base interest rate by 0.75 percentage points at their September meeting
• Further hikes are expected with the long term rate projected to hit 4.4% in 2023
• It’s bad news for businesses and the economy in general, with markets tumbling after the announcement.
• Investors need to think outside the box to generate profits in this type of environment, and pair trades are one option to consider.

It was widely expected that the Fed would increase rates by 0.75 percentage points at their September meeting, marking the third time in a row they’ve been increased. And that’s exactly what happened.

The increase brings rates up to a range of 3-3.25%, their highest level since before the huge wave of cuts that came as a result of the 2008 global financial crisis.

In addition to releasing their latest target interest rate, the Fed also announced their revised economic projections through the rest of this year and into 2023.

It paints a pessimistic picture which is unlikely to calm the nerves of both businesses and investors, but luckily there are always avenues to explore and unique angles to seek profits.

Let’s go through the Fed’s announcement and look at ways that investors can potentially generate returns in what is proving to be a challenging environment.

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Fed announcement overview

As well as increasing the base interest rate by 0.75 percentage points, Fed economists also provided a range of new projections for the economy.

Economic growth is expected to be an anemic 0.2% for 2022, before increasing modestly to 1.2% for 2023. Unemployment is expected to increase as well. Right now it sits at 3.7%, which is low, but it is expected to slowly rise to 3.8% by the end of the year and then up to 4.4% in 2023.

Perhaps more surprising is that the Fed is projecting inflation to drop significantly over the coming 12 months. As of this meeting, the expectation is for the headline rate to fall to between 2.6-3.5% in 2023.

This decrease isn’t likely to come without pain to businesses and consumers, with the base rate expected to increase to 4.4% by the end of 2022 and go up again in 2024 to an estimated 4.6%.

What rate hikes mean for the housing market

The main aim the Fed has in increasing rates is to reduce consumer spending. When the base rate increases it makes borrowing for the banks more expensive. This increase in costs is passed on to their customers in the form of an increase in interest rates on debt.

Whether this is on personal loans, car loans, credit cards and of course, mortgages, it makes them all more expensive.

Increasing the cost of debt means households have less money to spend on other things. Less money means a reduction in demand for goods and services, which increases supply and brings prices down. Or at least stops them rising so fast.

It’s not good for businesses but it does take the heat out of inflation.

Mortgages have the biggest impact on household budgets because they’re generally one of, if not the, biggest expense they have.

The average rate on a 30 year mortgage has recently increased to 6.25%. This is the highest level seen since the days of the 2008 global financial crisis.

This is an increase of 35 basis points that occurred prior to the Fed meeting, with the expectation of the 0.75 percentage point rate hike already priced in. It means we may not see a further increase from here, at least until the next Fed meeting draws closer.

As for the wider housing market, it’s not expected to avoid the damage that is projected to be felt by the rest of the economy. Fed chairman Jerome Powell stated that the housing sector is likely to go through a correction after experiencing a period of “red hot” prices.

How will savers be impacted?

On the other hand, a rate hike is good news for savers. The often forgotten group when it comes to changes in the base interest rate, they have the opposite problem to borrowers.

Low interest rates means there is less incentive to save, with meager levels of interest forcing people to look for other ways to generate a return. When the Fed is trying to stimulate the economy, this is a good thing.

Low rates on bank savings can mean more money going into assets like bonds and stocks, which can increase market activity and boost prices. It can also lead to increased spending as there is less incentive to put money away.

This has been the situation since 2008, with savers now used to receiving next to nothing on their savings accounts and CD’s. With interest rates on the rise, this may be finally starting to change.

Increased rates means that banks can offer great interest on their cash based accounts. As you’d expect, it has the opposite effect to the dropping of rates. Savers start become more incentivized to keep their cash in the bank, if they feel they’re getting a decent return.

With bank rates often down below 1%, it’s been a bit of a no-brainer for savers to consider putting that money in the stock market instead. If rates increase to 4% or even more, that question becomes much less clear cut.

Of course a 4% interest rate is still negative in real terms if inflation continues to run as high as it is right now, but nonetheless we may see increasing savings and CD rates start to shift some consumer behavior.

For business this is more bad news, because it again takes more cash out of the system which means less money spending.

All of this is in the hope of bringing inflation down. Fed chairman Jerome Powell has clearly stated that this is their number one priority, even if it means damaging the economy in the short term.

How did the stock market react to the rate hike?

Despite being widely expected and supposedly priced in, the S&P 500 fell 1.71% in trading on Wednesday. Concerns are growing on the outlook for the US economy, with Powell’s announcement showing that a recession is looking more and more likely.

The Nasdaq Composite fared even worse, falling 1.79% throughout Wednesday and the Dow was down 1.70%.

It’s likely that the fall in markets was experienced not as a result of the September rate hike, but rather the expectation and the clarity provided on further increases. There are two further meetings of the Federal Open Market Committee (FOMC) before the end of the year, and it would be a surprise if there weren’t rate hikes announced at both.

What options do investors have right now?

With interest rates increasing on cash accounts, it might be tempting to move some funds out of the markets and into this safe haven.

There’s’ a couple of major issues with that. Number one is that most investors are likely to be sitting on some pretty hefty losses right now, and selling and moving to cash is going to lock these in.

The best CD rates on the market are still only just over 3%, and these come with serious lock-in periods of up to five years. With inflation still running at very high levels, you’d be locking in a negative real return.

That’s not a great strategy.

So we’re probably heading for some economic turbulence, the stock market is already looking choppy and cash still isn’t coming to the party. You could try and stock pick, but that’s fraught with danger and it could easily end up worse than just sitting your money in the bank.

One answer is to use pair trades to invest in relative valuations. We’ve created a number of Investment Kits that utilize pair trades to do just that.

A great example is our Large Cap Kit. In volatile markets, big companies tend to outperform small and mid-sized ones. They tend to have more stable revenue, more cash reserves to fall back on and have less reliance on bringing in new customers to generate profits.

That’s not to say they can’t fall in value, but they’ll often fall less than smaller companies who can find economic slowdowns very tough to navigate.

The Large Cap Kit looks to take advantage of this differential by taking a long position in the biggest 1,000 companies and a short position in the next 2,000. It means that even if the market goes sideways, or even down, investors can profit as long as large companies hold up better than small or medium sized ones.

It’s the kind of trade that’s usually reserved for baller hedge fund clients, but we’ve made it available for everyone.

Download Q.ai today for access to AI-powered investment strategies. When you deposit $100, we’ll add an additional $100 to your account.