Why 5% Interest Rates Might Not Derail the Stock Market or the U.S. Economy

For many investors, the Federal Reserve increasing interest rates to 5% or more is a cause for concern. The belief is that such a move could wreck the economy and cause stock prices to plummet. However, there is reason to believe this may not necessarily be true.

One scenario is that little will change, and credit markets could tolerate interest rates that prevailed before 2008. The Fed’s policy rate could increase slightly from its current range and remain there for a while. Ben Snider, Managing Director and U.S. Portfolio Strategist at Goldman Sachs Asset Management said, “A 5% interest rate is not going to break the market.” Many highly-rated companies have refinanced old debt during the pandemic and continue to benefit from low-interest rates.

Another reason 5% interest rates may not be disastrous is that profit margins remain strong. Although they have been coming down, they are still very high and trending lower. Inflation remains slightly above target, but there are hopeful signs that many highly-rated companies would start from a strong position should a recession unfold shortly.

It’s worth noting that the Fed and other global central banks have been increasing interest rates dramatically to fight inflation brought on by supply chain disruptions, worker shortages, and government spending policies. Moreover, Fed Governor Christopher Waller has warned that interest rates may need to increase more than markets currently anticipate to restrain the rising cost of living.

Related Facts:

– Higher interest rates led to significant losses in stock and bond portfolios in 2022.
– Silicon Valley Bank’s collapse last month after selling “safe” but rate-sensitive securities at a significant loss sparked concerns about risks in the U.S. banking system and fears of a potential credit crunch.
– PGIM Fixed Income’s U.S. Investment Grade Corporate Bond Team sees corporate borrowing costs staying higher for longer but also sees many highly rated companies starting from a strong position if a recession unfolds shortly.

Key Takeaway:

While a 5% interest rate would mark a significant increase from the range we currently occupy, the signs suggest that such a move may not be as catastrophic for the economy and stock market as some predict. Highly rated companies are well-positioned to continue benefiting from low borrowing costs, and profit margins remain strong, even if they’re beginning to trend lower. Of course, there is no guarantee that such a move would come without its challenges, but the outlook may not be as bleak as some might suggest.

Conclusion:

The idea of interest rates rising to or beyond 5% is undoubtedly a cause for concern for many investors. However, evidence suggests that this scenario may not prove quite as disastrous as some predict. While there will undoubtedly be challenges, many highly-rated companies remain well-positioned to weather the storm, and profit margins remain robust, even if slightly lower than peak levels. Ultimately, only time will tell, but the outlook may not be as bleak as some predict.