Historically, rising interest rates have hurt individuals by making two of their biggest purchases--the automobile and the family home--more expensive.
But now, with more individuals owning stock than ever before, rising interest rates are threatening family finances in a third way, one that could ultimately spell an end to the stock market-driven "wealth effect" fueling the current economic boom.
Certainly the country's red-hot housing sector has cooled somewhat, with housing starts, residential construction spending and mortgage loan applications down in recent months. But sales of new and existing homes are still running close to record levels, and auto sales are on track to set a record of more than 17 million this year.
But it is in the stock market, where the values of some high-technology companies have been driven to stratospheric levels, where interest rate jitters have been felt most strongly. Yesterday's 267-point sell-off in the Dow Jones industrial average, market strategists said, was largely attributable to fears that interest rates are headed further upward after two summer rate increases by the Federal Reserve Board.
"The rate increase and the prospect of more rate increases have cooled the equity market," said economist Ray Stone, of Stone and McCarthy Research Associates in Princeton, N.J. "Consumers will probably slow their spending."
Rising rates make stocks less attractive investments compared with the safety and guaranteed return of Treasury bonds. Rate increases are particularly unnerving to investors in high-technology shares, because those companies trade at much higher multiples of their earnings, which become more diluted in future value as interest rates rise.
The huge run-up in the stock market over the past few years has helped sustain the consumer-driven economic boom by making consumers feel wealthy enough--thanks to their growing stock portfolios and retirement accounts--to spend more than they make.
But if the market continues to weaken, economists fear the wealth effect could lose its punch and even reverse as investors withdraw money from the markets to sustain their standards of living.
That won't happen overnight, unless interest rates rise much more rapidly or a much sharper correction in the stock market occurs, analysts say.
"Higher interest rates really haven't affected the psychology of people who have huge equity gains, especially if they think those gains will go on forever," said Kathleen Camilli, chief economist at Tucker Anthony Inc.
Interest rates began their upward trek long before Fed policymakers approved two quarter-point increases in June and August. The major reason: recovering economies in Asia and elsewhere that began to compete with the United States for investment capital and the continued strong performance of the U.S. economy despite the best hopes of the Fed and economists that it would cool down.
Strong demand for credit and concern about the inflationary impact of stronger-than-expected growth pushed the yield on the bellwether 30-year Treasury bond to 6.26 percent yesterday. That's a 26 percent rise from the 4.96 percent yield of last December.
Other interest rates have also risen, with the rate on the 30-year fixed mortgage at about 7.8 percent now, a full percentage point higher than at the end of last year. While mortgage refinancings have all but dried up, sales of existing homes continue at a brisk pace as home buyers have adapted to the higher financing costs by switching to adjustable-rate mortgages and putting more money down.
But such strong economic barometers are of little comfort to the stock market--and may even be contributing to its swoon, as a sturdy economy could mean the onset of higher inflation.
"The stock market is being held hostage by the bond market," said Charlie Crane, chief market strategist for Key Asset Management. "Now that long-term rates are going up and we have an apparently hostile Fed, investors are choosing to concentrate on interest rates as opposed to ignoring them."