The Potential Winners and Losers of Higher Interest Rates

October 16, 2023 Kathy JonesKevin Gordon
A look at who benefits and who suffers when the Federal Reserve raises interest rates.

The Federal Reserve's current rate-hike cycle, which began in March 2022, has pushed interest rates to levels not seen since 2007. That's welcome news to those looking to earn meaningful returns from bonds and cash but can hurt those needing to borrow for big-ticket items, like cars, college, or housing. However, where we are within a given rate-hike cycle can change that equation.

That's because rate-hike cycles, which the Fed uses to tame inflation and cool an overheating economy, ultimately lead to the point where an economy that's too strong threatens to become too weak. When that happens, the winners and losers can—and often do—switch places.

Here's a look at what normally happens in the early and later stages of rate-hike cycles, and who stands to win and lose within each phase.

Early in the cycle

Rate hikes make it more expensive to borrow, discouraging consumers from making large purchases and companies from hiring and investing. Over time, the effects of these trends can ease price pressures, but they can take a while to play out.

The winners

Unsurprisingly, bond buyers, lenders, and savers all benefit from higher rates in the early days. Bond yields, in particular, typically move higher even before the Fed raises rates, and bond investors can earn more without taking on additional default risk since the economy is still going strong.

The losers

Bond-fund investors, borrowers, and certain industries feel the pinch as soon as rates move upward:

  • Bond funds, which regularly buy and sell their underlying holdings, can experience losses in the net asset value in the short term due to the inverse relationship between rates and bond prices. However, as they reinvest in new bonds paying higher rates, they often recover their losses.
  • Borrowers who hold variable-rate debt, such as credit card balances and adjustable-rate mortgages, may see their payments increase almost immediately.
  • Stocks in the consumer discretionary, industrials, and materials sectors tend to underperform in the year following the start of a new rate-hike cycle as investors anticipate that higher borrowing costs and inflation will sap profits for those companies more dependent on economic growth.

Later in the cycle

As higher rates begin to weigh on the economy, the threat of recession often looms large. Yet opportunities remain for savers and for stocks within certain industries as rates climb toward their peak.

The winners

  • Savers continue to benefit as interest-bearing cash investments pay ever-higher yields. For example, some of today's CDs and money market and savings accounts are paying a meaningful 5% or more.1 

What a difference a percentage point makes

A higher rate, coupled with compound interest, can mean a substantial jump in your savings.

After five years, $100,000 deposited into a savings account would be worth $105,101 if the account yielded 1% annually, $110,408 if it yielded 2% annually, $115,927 if it yielded 3% annually, and $121,665 if it yielded 4% annually.

Source: Charles Schwab.

The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product. Example assumes an initial investment of $100,000 and a consistent interest rate for all five years.

  • Short-term bonds offer better yields, too, and even longer-term bonds become more attractive—10-year Treasuries, for example, are currently paying 3.99%,2 which, after more than a decade of rock-bottom yields, is a welcome change for income-focused investors looking to lock in higher monthly payouts.
  • Stocks in industries that provide essential products and services—such as health care, household goods, and utilities—become more attractive when recession concerns mount, given that their revenues aren't closely correlated with economic growth.

The losers

Unfortunately, there are many individuals and entities who suffer during the late stages of a rate-hike cycle—particularly borrowers. For example, college undergraduates who take out federal loans for the 2023–2024 school year will face the highest interest rates in more than a decade. Today's soaring rates may also help explain why first-time homebuyers accounted for just 26% of U.S. home purchases last year—the lowest level in 41 years, according to the National Association of Realtors. On the business side, high-yield bond issuers are at greatest risk from higher rates, and stocks in high-growth industries, such as information technology, can also suffer as revenues slip while borrowing costs remain high.

Eyeing the end game

Ultimately, everybody wins if the Fed can successfully tame inflation while keeping the economy out of a recession and preventing a significant increase in the unemployment rate. But a recession may be unavoidable, in which case it can pay to play it safe with your investments. Focusing on stocks and bonds from financially sound companies and issuers, respectively—and diversifying your holdings across industries and countries—can help limit the impact on your portfolio should an economic decline come to pass., as of 07/11/2023. 

2The Wall Street Journal, as of 07/11/2023.

Discover more from Onward

Keep reading the latest issue online or view the print edition.

Onward magazine print issues next to a laptop showing the Onward hub

Keep reading the latest issue online or view the print edition.

Investors should consider carefully information contained in the prospectus or, if available, the summary prospectus, including investment objectives, risks, charges, and expenses. Please read it carefully before investing.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk including loss of principal. 

Diversification and asset allocation strategies do not ensure a profit and cannot protect against losses in a declining market.

Past performance is no guarantee of future results.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.

The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner, or investment manager.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, political instability, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Commodity-related products carry a high level of risk and are not suitable for all investors. Commodity-related products may be extremely volatile, illiquid and can be significantly affected by underlying commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.