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What Happens To Stock and Bond Prices When Rates Fall?

Written by The Inspired Investor Team | Published on May 15, 2024

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This article was last updated in June 2024.

When interest rates come down, the question that’s on many investors’ minds is: how could it impact my portfolio?

Markets twist and turn for all sorts of reasons, whether driven by economic factors like employment figures, or supply chain problems, but an interest rate move in either direction almost always has some implications for stocks and bonds. And in the case of falling rates, stock and bond prices have often, but not always, moved up.

“When interest rates decrease, then asset prices should increase,” says Claire Célérier, the Canada Research Chair in Household Finance and an Associate Professor of Finance at the Rotman School of Management. Although in the case of economic recessions, stock prices may decrease as well.

Not every investment, though, will react to a change in rates in the same way or at the same pace, she adds. It’s impossible to predict how individual stocks will respond, but knowing the way in which the market reacts to lower rates is important when planning your next trade.

Interest rate impact

Interest rates affect markets because they impact the relative attractiveness of one asset class compared to another. After the Great Recession in 2008 and until 2022, interest rates were at historically low levels – near zero in many cases. That made stocks a lot more appealing than bonds because you could, in theory, earn more in the stock market through earnings growth and dividends than you could from the yield a bond would pay, which is more directly tied to interest rates. Stocks did well over that period, with the S&P 500 climbing by 461% between March 6, 2009, when stocks hit their bottom after the recession, and the end of 2022.

That began to change a couple of years ago when interest rates started to rise, but especially over the last 12 months when central banks stopped increasing rates. Bonds became more attractive to investors – if one can earn 5% in a fairly risk-free investment, such as a government fixed-income security or a high-interest savings account, many investors will choose securities that provide safety.

But where do things go from here? We look at how stocks and bonds may react to declining rates.

Bonds could bounce

When interest rates fall, bond prices tend to increase, and vice versa. That’s because the government bond you bought with the 5% yield becomes more attractive when you can now only buy a government bond with a 4% yield. People will pay a little more to get that extra income, says Célérier.

In 2022, existing bonds had their worst year on record because of increasing rates – you had to sell your fixed-income securities for less money because investors could get new ones with higher yields.

You don’t need to wait for a rate cut to see bond prices rise, though. Yields on longer-dated bonds, like a 10-year or 30-year bond, fluctuate constantly, moving in part on where people think rates may go in the future, as well as the outlook for the economy. If investors estimate rates could fall in, say, three months from now, you might see yields come down, increasing the price of your bond. If expectations change and rates may not fall until next year, the yield on those longer bonds could rise, causing your bond’s value to drop.

Shorter-term bonds – ones that mature in one or two years – react more strongly to a central bank rate cut because they signal where rates are at today or will be in the very near future. Another attribute of bonds is that prices could still climb even if there is a more extreme slowdown. “Bonds are much less sensitive to lower growth than equities,” notes Célérier.

More attractive stocks

Equities movements are less predictable. Stock prices often rise when rates fall because bonds offer lower yields and investors must take on more risk (i.e. equities) to achieve their desired rate of return. Often, less volatile dividend-paying sectors, such as utilities or real estate investment trusts, see a boost because they’re considered bond proxies – their earnings are stable, and they pay a decent yield that’s in line with, or more attractive than, fixed income.  (Of course, they’re still equities, so they do carry more risk than bonds.)

Other factors can support equity prices, too. When rates fall, borrowing costs drop, whether it’s your variable-rate mortgage or the line of credit a business taps into to run its operations. If you can pay down debt faster, then you have more money to spend or invest. Those dollars will find their way into company coffers, increasing earnings and, ultimately, stock prices. Similarly, if companies have more money and access to lower-cost borrowing, they can spend on expanding. For sectors like tech, where investors put a high value on growth, that can help buoy prices.

But just because stocks are supposed to rise when rates fall, doesn’t mean they will. Equity markets move for all sorts of reasons, but when it comes to rates specifically, ask yourself why they’re declining. Is it because inflation is cooling or because we’re heading into a major economic slowdown? If it’s the latter, then equity prices could be negatively impacted. If people are worried about job losses, for instance, they’ll spend less, and that will affect company earnings, says Célérier. The other issue is that no one knows how much of a rate cut is already priced into equity markets, she explains.

While it’s a good idea to think about how rates could impact your investments going forward, other criteria such as your goals, time horizon and risk appetite are also important considerations when determining how best to position your portfolio.

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