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

Interest rates have been making headlines since the pandemic. Ultra-low inflation, followed by historically high price increases between 2020 and early 2023, prompted many consumers and investors to pay attention to interest rates and how the Fed manages them.

The Fed 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 influences banks’ cost of capital, so they use it to set pricing on loans made to consumers and businesses. Said another way, 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 rate actions too. Lower rates can prompt a rise in stock prices, while higher rates can push stock prices lower. But what happens when the Fed leaves rates the same? Let’s answer that question now, and share some tips on adjusting your portfolio to the current rate environment.

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

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

Learn more: Jobs, inflation, and the Fed: How they’re all related

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

Investor expectations can trigger stock price swings when those expectations diverge from the Fed’s decision. For example, if investors believe the Fed should have cut rates, stock prices can drop. If investors believe the Fed should have raised rates, stock prices can rise. As David Russell, global head of marketing strategy at trading platform TradeStation, explained, “The Fed’s main impact on the stock market is to confirm or reject expectations about rates and the economy.”

You can get a sense of current investor expectations by checking CME FedWatch. This resource uses 30-day federal funds rate futures prices to predict the Fed’s rate actions.

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

Consider three questions:

1. Have you updated your holdings recently on the assumption that rates would change? If so, reevaluate your portfolio now. Confirm you are comfortable with your allocations given a more modest outlook for rate declines.

2. If you have made changes, are you still comfortable predicting interest rates and economic trends? Molding your investments to fit current and future circumstances can create higher returns — only if most of your predictions are accurate. However, betting wrong once or twice can undermine returns. The good news is you can get off the prediction roller coaster by adopting a long-term strategy instead. That involves setting up an allocation to rely on continuously rather than adjusting for short-term circumstances.

3. Is your strategy largely unchanged from last year or the year before? The advantage of a long-term approach is feeling comfortable holding your portfolio steady through rate changes and economic cycles. If your current strategy is working for you, there probably isn’t a reason to change.

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The federal funds rate is one factor among many that affects the investment climate and stock prices. If you intend to manage your investments to suit the current environment, keep a close watch on broader economic and corporate profit trends, as well as interest rates.

Ultimately, corporate profits are the main factor driving stock prices. Profits are affected by interest rates, consumer and business spending, inflation, and more. Many investors respond to these factors as predictors of profit trends. As noted, the predictive approach comes with the risk of being wrong.

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

Tim Manni edited this article.