Quora Answer: If the Federal Reserve Increases Rates in 2022, Would It be Wise to Make Financial Decisions Earlier?

The following is my answer to a Quora question: “If the Federal Reserve increases rates sometime in 2022, would it be wise to make financial decisions earlier in the year?” 

Inflation is the rise in the price of goods and services in the economy.  The general tendency is that the interest rate and inflation rate have an inverse relationship.  In general, when the interest rate is low, the economy grows because borrowing and credit is cheap.  This growth feeds inflation.  Conversely, when the interest rate is high, the economy slows down because borrowing becomes expensive, curbing inflation.  The federal Reserve utilises monetary policy, the manipulation of interest rate, to control inflation. 

The Federal Reserve is expected to increase interest rates in 2022.  They held off raising interest rates because the Federal Reserve prioritised economic recovery after the recession cause by Covid19.  They underestimated the speed of economic recovery and pent-up demand, because there is no recent precedent to this global economic.  Inflation in the US is too high, as it is, and severely affecting the cost price index, meaning goods and services are a lot more expensive, and the price increase has overtaken growth in real wages.  In effect, the American population has reduced purchasing power.  Countries with economies closely tied to the American economy, or currencies pegged to the US dollar, are experiencing the same problem.

In terms of investments, it would be best to restrategise for a longer investment horizon.  In the short term, this increase in inflation has an impact on the market which mirrors the wider economy.  Because purchasing power is diminished, fewer counters can be bought.  Because consumer purchasing power is diminished, revenue and profits decline, which eventually leads to slower growth.  This is not the immediate case for the moment due to pent up global demand which is driving inflation.  In this period, value stocks, the stock of companies with low price to book ratio, low price to earnings ratio, and high dividend yield, tend to outperform the market.  In the short-term, the market is extremely volatile in this inflationary period.  Growth stocks are the most affected.  In such an environment, consider inflation-resistant stocks such as the energy sector, pharmaceuticals, and REITs.  They tend to grow in value alongside inflation rate.  Because of the expected higher interest rates, fixed-income instruments will be adversely affected.  Their prices will move opposite to their yields. 

In terms of loans, if you have borrowing needs, it would be better to consider borrowing before the interest rate rises.  That would make all your loans, whether housing, mortgage, or credit lines, more expensive.  You may consider moving excess funds out of your savings account or fixed deposit, into investments than can keep up with this inflation.  You may also need to consider adjusting your portfolio and loans if you are retiring within the next three years.  Otherwise, you may find that you have less funds than anticipated during your retirement years.