What’s the deal with inflation and interest rates? (Article)
What’s the deal with inflation and interest rates?
Generally, inflation and interest rates have an inverse relationship, in other words if one is going up the other is probably going down. Very simply put, if interest rates are going up, people will save more and spend less. This is because they can earn more on their savings accounts and loans are more expensive. This results in less demand for goods and services, increasing supply and lowering costs. However, when interest rates go down, there is less reason to save and more reasons to borrow and spend, increasing demand, and prices. This increase in prices is also called inflation.
So, is inflation good or bad for the stock market? Well, initially it is good. Afterall, when inflation is going up, it can be a sign that consumers are spending, and the economy is expanding. So, while you’re not earning much interest on your cash, your 401k loves it. However, if prices get too high, or inflation rises too quickly, it could result in a dramatic shift in consumer spending behavior, even if interest rates are still low. This is where investors find themselves today. Not wanting to miss the rally, but afraid that at any moment consumer spending may shift and the whole wave will come crashing down. So, what should you do?
For one, listen to the Fed. They are watching inflation trends like a hawk, and we expect them to begin raising interest rates once inflation has some momentum, but before it balloons out of control. Second, if you’re short on time before retirement, consider downshifting your asset allocation while stocks are trending up. Lastly, if you have the time, diversify for the long-term, because a diversified portfolio is the best way to benefit form market trends while also reducing volatility.
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