How are stocks impacted when the Fed doesn’t change interest rates?

Interest rates have been in the headlines since the outbreak of the pandemic. Ultra-low inflation, followed by historically high rates between 2020 and early 2023, has led many consumers and investors to pay attention to interest rates and how the Fed manages them.

The Federal Reserve adjusts interest rates — specifically, the federal funds rate — to address inflation and unemployment trends. The federal funds rate is what banks charge each other for overnight loans. This rate affects banks’ cost of capital, so they use it to determine the pricing of loans to consumers and businesses. In other words, the rates you pay on credit cards, auto loans, and personal loans generally rise and fall with the federal funds rate.

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Stock prices often react to the Fed’s interest rate actions as well. Low interest rates can cause stock prices to risewhile higher interest rates can push stock prices down. But what happens when the Fed leaves interest rates as they are? Let’s answer that question now, and share some tips on adjusting your investment portfolio to match the current price environment.

The Fed’s management of interest rates requires finding a careful balance between stimulating the economy and controlling inflation. Lower interest rates boost consumer and business spending, which is good for stock prices. However, if interest rates fall too quickly, inflation could rise – and that’s bad for stock prices.

The Fed’s decision to leave interest rates unchanged indicates that the economy is strong, but inflation could easily return.

Learn more: Jobs, Inflation, and the Federal Reserve: How They’re All Connected

In theory, stable interest rates should not lead to significant changes in stock prices. But there is another factor to watch: the expectations of the investment community.

Investor expectations can cause stock price fluctuations when those expectations differ from the Fed’s decision. For example, if investors believe the Fed should lower interest rates, stock prices could fall. If investors believe the Fed should have raised interest rates, stock prices could rise. As David Russell, global head of marketing strategy at trading platform TradeStation, explains, “The Fed’s main influence on the stock market is to confirm or reject expectations about interest rates and the economy.”

You can learn about current investor forecasts by checking CME FedWatch. This resource uses 30-day federal funds rate futures prices to forecast interest rate actions by the Federal Reserve.

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With interest rates remaining unchanged and investors agreeing with the Fed’s strategy, are portfolio adjustments necessary? The answer depends on the current state of your investments.

Think about three questions:

1. Have you recently updated your holdings assuming prices would change? If so, reevaluate your portfolio now. Make sure you’re comfortable with your allocations under more modest expectations of lower interest rates.

2. If you make changes, are you still comfortable predicting interest rates and economic trends? Shaping your investments to fit current and future conditions can deliver higher returns – only if most of your forecasts are accurate. However, making the wrong bet once or twice can undermine your returns. The good news is that you can break out of the forecasting spiral by adopting a long-term strategy instead. This involves creating an allocation to rely on on an ongoing basis rather than adjusting it to short-term circumstances.

3. Is your strategy largely unchanged from last year or the year before? The advantage of a long-term approach is the comfort of keeping your portfolio stable through price changes and economic cycles. If your current strategy is working for you, there is probably no reason to change.

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The federal funds rate is one of the factors that affect the investment climate and stock prices. If you intend to manage your investments for the current environment, keep a close eye on broader economic and corporate profit trends, as well as interest rates.

Ultimately, corporate profits are the main factor that drives stock prices. Earnings are affected by interest rates, consumer and business spending, inflation, and more. Many investors respond to these factors as predictors of profit trends. As mentioned, a predictive approach comes with the risk of error.

If you prefer to stay conservative, fill your portfolio with high-quality stocks that have proven themselves through all economic cycles. Then wait patiently for long-term growth.

Tim Money Edit this article.