Is the prospect of rising interest rates battering ASX shares?

What’s behind the slump in the ASX share market? We take a closer look.

| More on:
A woman in a business suit and a man in a business suit boxing in a ring.

Image source: Getty Images

Key points

  • Both the ASX and global share markets have had a tough few months
  • Many are blaming this on inflation and the prospect of rising interest rates
  • But why would higher rates affect ASX shares?

As many ASX investors would know by now, the S&P/ASX 200 Index (ASX: XJO) has been in a bit of a funk for a few months now. Friday in particular saw the ASX 200 shed a nasty 2.27% to finish the trading day at 7,175.8 points. That leaves the ASX 200 below where it was 6 months ago, and at its lowest point since June last year. Ouch.

Over in the United States, markets haven’t been quite as gloomy. But even so, the flagship S&P 500 Index is now down around 6.5% from its last peak. Many investors have blamed the prospect of inflation, and the higher interest rates that come with it, for the slump in global markets that we’ve seen.

Indeed, the 40-year high inflation reportedly hit earlier this month in the US aligns rather well with the share market slump we have seen across the US and Australian markets since then.

But why is this the case? Wouldn’t the debt-destroying powers of inflation be good for markets?

Why do inflation and higher interest rates spook investors?

Well, not exactly. Sure, inflation does normally mean that both corporate and government debt can be ‘inflated away’. But it’s what normally walks hand-in-hand with inflation that could be spooking markets. That would be higher interest rates.

As the great Warren Buffett once said, interest rates are like financial gravity, pulling everything down to earth. Over the past few years, interest rates around the globe have been at virtually zero. This was a deliberate consequence of central bank intervention to assist the global economy in dealing with the COVID-19 pandemic. Lower rates typically result in cheaper loans, helping to give consumers a spending boost.

But as rates start rising, so too does the cost of borrowing money for every participant of the economy. That includes consumers, businesses, and governments.

If rates were to rise, so too would the cost of a business wanting to borrow money to expand its operations. And that goes for homeowners too. If the Reserve Bank of Australia (RBA) were to raise our own cash rate from the current 0.15% to say 1% or even 2% over the next couple of years, it would mean anyone with a home loan would see their mortgage repayments increase substantially.

So in an inflationary environment, businesses would have to watch their own borrowing costs rise, as well as the purchasing power of many of their consumers fall. All while inflation is driving up the cost of production and labour. So you can see why investors might be spooked by the prospects of inflation and higher rates today.

That is possibly the reason why we have seen both the ASX and the global share market go through some pretty nasty volatility over the past few months. But only time will tell how the macro-economic environment will treat shares in 2022.

Wondering where you should invest $1,000 right now?

When investing expert Scott Phillips has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for over ten years has provided thousands of paying members with stock picks that have doubled, tripled or even more.*

Scott just revealed what he believes could be the five best ASX stocks for investors to buy right now. These stocks are trading at near dirt-cheap prices and Scott thinks they could be great buys right now.

*Returns as of January 12th 2022

Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on Economy

A businessman keeps calm in the face of inflation
Economy

Inflation to ‘peak shortly’: CBA boss says markets have priced in too many rate rises

The big bank forecasts fewer rate hikes from the RBA than consensus expectations.

Read more »

A mum levitates in a state of calm above the kitchen in her home, while the busyness and noise of kids, food and the chaos of everyday living whirls around her.
How to invest

‘Do not panic’: Experts explain how to stay calm and carry on investing amid rising interest rates

At the current inflation rate, the cost of living in the United States will double in just over eight years…

Read more »

Two mature women learn karate for self defence.
Economy

Is the Telstra share price a defensive buy during times of market uncertainty?

What do analysts like about Telstra?

Read more »

Percentage symbol in white with a black rising arrow.
Economy

Running against rates! Which ASX shares could be the winners and losers?

How do higher interest rates affect ASX shares?

Read more »

A mature age woman with a groovy short haircut and glasses, sits at her computer, pen in hand thinking about information she is seeing on the screen.
Share Market News

What rising interest rates can do to ASX shares

The Reserve Bank of Australia finally bit the bullet on Tuesday. What might this mean for your stock portfolio?

Read more »

Two men lok sxcited on the trading floor.
Economy

Here’s how some of the biggest ASX 200 shares are responding to the RBA’s rate rise

The RBA just increased the interest rate. Here’s how ASX 200 shares are reacting.

Read more »

An oil refinery worker stands in front of an oil rig with his arms crossed and a smile on his face as the Woodside share price climbs today
Earnings Results

Here’s what makes Santos shares ‘a really exciting proposition’: expert

Could the Santos share price keep climbing?

Read more »

a group of business people in business attire join their hands in the middle of a circle in a team celebration as they smile broadly in celebration of a milestone event.
ETFs

5 ASX ETFs to combat inflation: fund manager

The fund manager BetaShares believes certain ETFs can provide resilience.

Read more »