Explained: How do rising interest rates impact different asset classes?
Over the past year, central banks around the world have been raising interest rates to control soaring inflation. The central banks use this tool to monitor the currency flow and liquidity in the system. By increasing interest rates, they make borrowing expensive, reducing liquidity and demand in the economy and ultimately calming down inflation.
As investors, it is critical to know how a rise in interest rates affects different asset classes. Check it out:
Impact on Equities
One of the most significantly impacted asset classes is equity. Although interest rates do not directly affect stock prices, decisions made by central banks can lead to changes in investor sentiments. Higher interest rates make borrowing costly. This can lead to a slowdown or higher expenditure. Additionally, reduced consumer spending can lead to lesser revenues for many companies.
Due to expectations of such declines and slowdowns, the stock market can see some negative sentiment. However, certain sectors like banking, insurance and brokerage tend to perform well due to higher revenue expectations. Rising interest rates can also lead many investors to move their funds from riskier assets like equities to safer instruments like bonds or debt securities.
Moreover, rate-sensitive sectors such as automobile and real estate can have a negative impact of rising interest rates.
Impact on Bonds
The bond market reacts negatively to rising interest rates. When interest rates rise, the value of existing bonds declines as investors tend to shift to new bond issues with higher interest rates.
The existing bonds become less attractive to investors because as their value decreases, their yields rise. This means investors have to accept a lower return on their investments. Meanwhile, issuers of new bonds must offer higher yields, which reduces the value of lower-yielding bonds already in the market.
Impact on Gold
Gold is referred to as a safe-haven currency. However, the yellow metal tends to lose its shine amid the rising interest rate scenario. In theory, with higher interest rates, fixed-income securities become more attractive and investors opt to flee away from gold investments.
Additionally, gold is denominated in US dollars. Hence, when the demand for the US dollar rises due to an increase in interest rates, gold prices come under pressure.
Funds kept in fixed deposits or saving accounts may benefit from the higher interest rate. Real estate investments may not fare that well due to interest rate hikes. It is because increased costs of financing and borrowing for consumers make real estate investments expensive.
As investors, it is important to build a robust and well-diversified portfolio. Investing in equities, debt and other asset classes can help in reducing the overall impact of rising interest rates.
Disclaimer: Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Please refer the Risk Disclosure Document issued by SEBI and go through the Rights and Obligations and Do’s and Dont’s issued by Stock Exchanges and Depositories before trading on the Stock Exchanges. Brokerage will not exceed the Exchange prescribed limit.
The total value of foreign portfolio investors’ (FPI) holdings in the Indian equity market dropped to $584 billion at the end of December 2022.