When there are news of an interest rate hike, the people go wild and alert. The media, investors, and other market watchers are all keeping close tabs on any development. And that’s because interest rate changes can have varying effects across the economy.
As per expert Platform Review and HQBroker Review, it doesn’t only affect the economy, though. It also affects different markets, such as the stock market. This is not surprising. After all, the stock market is directly intertwined with the economy. And whatever affects the economy affects the stock market.
Let’s figure out how interest rates exactly affect the stock market.
Which rate influences stocks?
The interest rate that impacts stocks is the federal fund rate, which is also known as the overnight rate. The overnight rate is the amount of money that depository institutions pay when they borrow money from Federal Reserve Banks.
It can be considered as some kind of an inter-bank loan.
The Federal Reserve tries to control inflation through the federal funds. Inflation, meanwhile, is the increase in prices that is brought about by too much money to too few products. When the Fed increases the federal fund rate, the Fed tries to reduce the supply of money available for buying. In a way, they are trying to make money more difficult to get.
On the other hand, when the Fed decreases the federal fund rate, it increases the money supply. It makes money cheaper to borrow and thus bolsters spending.
Companies are affected when the Fed increases rates. Since these companies borrow from banks to grow and maintain their operations, they too suffer when the banks increases their borrowing interest rates.
Companies, therefore, might not borrow as much and will pay higher. If a company spends less on the expansion of the business, then there’s a big chance that the company will not grow. There might even a slump in their earnings as well. And when that happens, a public company’s stocks usually suffer the consequences—meaning its stock value will decline.
Interest Rates and the Stock Market
Whenever we see that a company is decreasing its spending or is earning less, then future cash flow will also decrease. This will lower the company’s stock price, all things considered.
When too many companies experience this kind of slump, the whole market or key indexes, which investors and people equate with the market, will also fall. If the expectation for growth and future cash flows lower, the investors will not get much growth from the stock price appreciation. This makes you think that owning stocks is less appealing.
Meanwhile, there are other industries and sectors that benefit from interest rate hikes. For one, the financial industry. Banks, brokerages, mortgage companies, and insurance agencies’ earning usually rise in conjunction with the interest rate hike. This is because they can charge their clients more from borrowed money.
The relationship of interest rate hikes and the stock market may be indirect, but they usually move in opposing directions. As a rule, when the Fed cuts interest rates, it pushes the stock market up. When the Fed raises interest rate, it causes the stock market to slide as a whole. However, you must remember that there’s no fool-proof way of predicting the reaction of the stock market to any interest rate move.