How do interest rate changes implemented by the Fed affect the stock market?

By Chris Gallant AAA
A:

The actions of the Federal Reserve are closely followed by the investment community. Scores of analysts work to interpret the statements issued by the Fed and also attempt to predict any changes to interest rates that the Fed might undertake.

Because of the effect of these expectations, there can be no guarantee about how the market will react to any given interest rate change the Fed chooses to make. However, as a general rule of thumb, when the Fed cuts interest rates, this causes the stock market to go up; when the Fed raises interest rates, this causes the stock market as a whole to go down. (For more insight, read How Interest Rates Affect The Stock Market.)

This is because lower interest rates make for cheaper debt financing, which allows businesses to expand their operations using debt capital at a lower cost. The expansion boosts the economy. Conversely, higher interest rates tend to cool off the economy, which can decrease stock valuations.

However, if expectations differ significantly from the Fed's actions, these generalized reactions need not necessarily apply. For example, if the bulk of the investment community expects the Fed to cut interest rates by 50 basis points at its next meeting, but the Fed only cuts interest rates by 25 basis points, this may actually cause the stock market to decline because expectations of a 50 basis point cut had already been priced in to the market.

To learn more about the Federal Reserve's role in our economy, check out How Much Influence Does The Fed Have?

RELATED FAQS

  1. How is interest charged on most lines of credit?

    Learn how most financial institutions calculate interest on lines of credit by using the average daily balance method and ...
  2. Where is cost of living lowest in the world?

    Learn how the cost of living is the lowest in India based on numbers derived from the CPI and organizations like Expatistan ...
  3. What are the main reasons for why there could be a negative gross profit margin and ...

    Find out how to calculate a company's gross profit margin, why a firm might experience a negative margin and how to interpret ...
  4. What economic indicators do agriculture investors need to watch?

    Agriculture investors should keep an eye on land prices, interest rates, inflation, harvest performance and speculative investment ...
RELATED TERMS
  1. Welfare Capitalism

    Definition of welfare capitalism.
  2. Treasury Direct

    The online market where investors can purchase federal government ...
  3. ICE LIBOR

    See LIBOR
  4. LIBOR

    LIBOR or ICE LIBOR (previously BBA LIBOR) is a benchmark rate ...
  5. Interest Rate Index

    An index that is based on the interest rate of a financial instrument ...
  6. LIBOR Scandal

    A scandal in which financial institutions were accused of fixing ...
Related Articles
  1. Success: Hard Work Or Good Fortune?
    Personal Finance

    Success: Hard Work Or Good Fortune?

  2. Main Characteristics of Capitalist Economies
    Economics

    Main Characteristics of Capitalist Economies

  3. How Long Will Equity Income ETFs Remain ...
    Investing

    How Long Will Equity Income ETFs Remain ...

  4. Understanding World Bank Data
    Investing

    Understanding World Bank Data

  5. India Is Eclipsing China's Economy As ...
    Economics

    India Is Eclipsing China's Economy As ...

Trading Center