Changing Interest Rates/Inflation: Should You Adjust Your Portfolio?

Jennifer Lippin
Vice President and Senior Wealth Advisor
Washington Trust Wealth Management

Inflation and interest rates are two of the most influential forces shaping your portfolio performance. Understanding how these forces interact—and how to respond—can significantly impact your wealth over time. Particularly during this period of uncertainty and volatility, now is a good time to sit down with your portfolio manager to discuss how to take advantage of the current economic climate. 

The Core Relationship: Inflation and Interest Rates 

Inflation, simply defined as the general increase in prices over time, eats into your purchasing power and reduces the ‘real’ return on your investments. It is important that your investments outpace the rising cost of living.

Interest rates, simply defined as the cost for borrowing money, are highly influenced by Central Bank policies, which serve as a key tool for managing inflation. 

• When inflation runs hot and the U.S. economy is strong, the Fed typically hikes rates to slow down the economy. This often results in decreased spending on both a personal and corporate consumer level, aimed at reducing prices for both parties over time.
• When inflation cools, and when facing the potential for either stagflation (stagnant growth coupled with inflation) or even recession (longer-term negative economic growth), the Fed typically lowers rates to spur growth. 

How They Affect the Market

These inflation/interest rate shifts affect everything from cash and bond yields to stock valuations. Bond prices are inversely related to interest rates. When interest rates go up, bond prices go down, and vice versa.ⁱ Throughout history, stocks have been one of the most favorable ways to outpace the impact of inflation over time. In a rising inflation environment, investing in stocks may offer a hedge against inflation pressure, as corporate revenues and profits, in theory, should grow along with inflation (with a possible adjustment period).  

When Inflation and Interest Rates Rise

What it means for you:

• Cash yields improve. Money Market funds, Certificates of Deposit (CDs), and short-term Treasuries become more attractive.
• Borrowing gets more expensive. If you're looking to take out a mortgage or a car loan, you’ll be paying higher interest.
• Bond prices fall. As new bonds offer higher yields, the market value of existing lower-rate bonds drops.
• Equity valuations compress. Higher rates reduce the present value of future earnings, which can weigh on growth stocks, in particular.

Smart moves to consider:

• Consider Treasury bills in addition to cash balances. These can offer solid, lower risk returns when rates are high.
• Lock in fixed-rate loans early. If you anticipate needing a mortgage or car loan, try to act before rates rise further.
• Be cautious with bonds. Focus on shorter duration, higher credit quality bonds.
• Tilt toward value-biased stocks. Companies with strong cash flows and dividends tend to outperform in rising-rate environments.

When Inflation and Interest Rates Fall

What it means for you:

• Lower yields on cash and savings. Money parked in savings accounts, CDs or money markets earns less.
• Loans become cheaper. Mortgage rates drop and car loans improve.
• Bond prices rise. Falling rates boost the value of all bonds — especially long-duration holdings.
• Stock markets may rally as risk appetite grows. Lower rates often boost investor optimism and company profits, benefiting growth-oriented stocks.

Smart moves to consider:

• Don’t hoard too much cash. Cash loses purchasing power faster when interest rates are low and inflation persists.
• Refinance your loans. Lower rates mean potential savings on your mortgage, student loans, or other debt.
• Consider extending fixed income duration and adding more credit risk.
• Increase equity exposure. Growth-oriented sectors (tech, consumer discretionary) tend to thrive.

Tax-Aware Opportunities

• Harvest tax losses during volatility. Market swings create opportunities to realize losses and rebalance risk.
• Consider Roth conversions in market dips. When valuations fall, converting pre-tax assets to Roth IRAs can be more tax efficient.
• Review municipal bonds. Yields from municipal bonds may offer attractive tax-adjusted returns, especially for high earners.

A Word on Timing and Strategy

As always, it’s important to diversify. Balance your stocks, bonds and cash according to your risk appetite. And think long term. Don’t overreact to short-term market swings. Rising and falling rates are part of economic cycles.

Washington Trust Wealth Management Can Help

Inflation and interest rates will ebb and flow throughout your investing lifetime. Turn to your Washington Trust Wealth Management team to work with you to adjust your asset allocation, rebalancing periodically, and seize timely opportunities to protect and grow your wealth while staying true to your long-term strategy.