Both the total market and small-value stocks performed better during periods of falling interest rates than during periods of rising rates. Small-value stocks, on average, outperformed during six-month periods of either rising or falling rates.
If the Fed lowers rates because inflation is slowing, the response should be positive. Businesses are likely to pursue growth more aggressively. Investors, expecting higher earnings ahead, may funnel more capital into the stock market. This can push stock prices higher.
When interest rates are rising, both businesses and consumers will cut back on spending. This will cause earnings to fall and stock prices to drop. On the other hand, when interest rates have fallen significantly, consumers and businesses will increase spending, causing stock prices to rise.
Bonds with short maturities, such as six months or one year, reach maturity relatively quickly. Because any change in interest rates would affect the bond owner for a comparatively limited time, these investments are less exposed to interest rate risk.
Bonds (Especially If You Already Own Them)
If you have reason to believe that interest rates will continue to drop, bonds become even better investments. “Bond prices typically rise as interest rates fall, so holding bonds during a period of rate cuts can lead to price appreciation,” Scibilia said.
Rate-sensitive companies such as small banks, real estate investment trusts (REITs) and heavy borrowers can benefit substantially from lower rates. They also help stock prices, with investors discounting future earnings at lower rates, boosting the present value of those future cash flows today.
Lower interest rates could benefit those looking to refinance or consolidate debt. Savers may need to look for other investment opportunities with higher returns as interest rates decline. The housing supply could increase and relieve pressure on previously skyrocketing home prices.
If an investor is looking for reliable income, now can be a good time to consider investment-grade bonds. If an investor is looking to diversify their portfolio, they should consider a medium-term investment-grade bond fund which could benefit if and when the Fed pivots from raising interest rates.
Despite high interest rates and rising unemployment, the U.S. economy grew by approximately a robust 2.9% in 2024, powered by resilient consumer spending. Traditional economic indicators consistently signaled contraction, yet the economy continued to expand, driven in part by a dominant U.S. services sector.
That's why you'll often see growth stocks, such as techs, rally when rate cuts may be on the table. High-yield bonds. These bonds often perform well when rates decline, as investors turn to securities that can deliver a higher return. Real estate investment trusts (REITs).
A decrease in interest rates will prompt investors to move money from the bond market to the equity market. The influx of new capital causes the equity market to rise.
Savers Earn More Interest
Banks increase the rates they pay to attract new customers and retain deposits from existing customers. Savings accounts and money market accounts typically increase within a month of the Federal Reserve increasing rates. However, your CD's rates are fixed until it matures.
Bank stocks are generally considered cyclical businesses. They tend to perform better during strong economic times and worse during recessions and other economic turbulence.
The Federal Reserve recently began lowering interest rates for the first time in over four years. Small businesses are particularly likely to benefit from the rate cut because many are dependent on bank financing and have floating rate loans.
Some stocks are especially sensitive to interest rates because of how their sector or business model operates; for example, utilities, REITs, and telecommunications companies often pay high dividends and are often bought for the income they generate for investors.