Written by Daniel Da Costa at The Motley Fool Canada

As we’ve seen over the last year and a half, rising interest rates can negatively impact companies across multiple industries in a variety of different ways. Even some of the largest Canadian blue chips have seen impacts on their stock prices as both the economic and market environments have worsened.

That doesn’t mean you can’t find high-quality stocks to add to your portfolio to help you hedge in this environment. In order to do so, though, it’s essential to understand how surging interest rates impact stocks.

Why do rising interest rates cause stock prices to fall?

The economy naturally goes through cycles in which it expands and grows rapidly, then peaks and starts to contract, falling into a recession before it eventually bottoms and starts to rebound when it begins to expand again.

Interest rates are used by central banks as a tool to help keep the economy on track. When the economy gets too hot and inflation soars, as we saw throughout 2022, it’s essential for central banks to try to cool the economy down by increasing interest rates.

The purpose of increasing interest rates is to reduce the money supply in the economy. When rates are higher it makes spending more expensive since debt costs more to service. It also incentivizes consumers to save since you can earn significantly more interest when rates are high compared to when they are lower.

So many stocks will see impacts on their revenue as a result of higher interest rates since consumers are incentivized to spend less and save more.

In addition, many companies, especially Canadian blue chips, use debt to finance their operations. So as interest rates rise it costs more to service the debt, increasing their expenses and hurting their profitability, which ultimately leads to a lower share price.

Finally, higher interest rates make new bonds more appealing than old bonds that pay lower interest. This causes the price of both bonds and stocks to fall since the availability of these new bonds makes dividend yields look unattractive in the current market.

Therefore, many dividend stocks will fall in value as rates rise, and their yields will increase as a result.

What Canadian blue chips are the best to buy now

When deciding what Canadian blue chips to buy in this rising rate environment, it’s essential to consider many important factors such as how much debt they have, how their revenue could be impacted by higher rates and how they could perform in a recession, since higher interest rates could slow the economy down enough that it falls into a recession.