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 does the International Chamber of Commerce define the term 'Free on Board' (FOB)?

    Find out more about the International Chamber of Commerce, Incoterms rules and how the International Chamber of Commerce ...
  2. How does duration impact bond funds?

    Learn how duration for a bond fund measures the risk the bond portfolio has to a rise in interest rates, and see how managers ...
  3. What are the primary factors that drive share prices in the chemicals sector?

    Learn about the primary factors that drive share prices in the chemicals sector. Chemical stocks combine aspects of cyclical ...
  4. What determines if an international trade is Ex Works (EXW) or Free on Board (FOB)?

    Find out more about the Incoterms rules and what determines if an international trade agreement is an ex works or free on ...
RELATED TERMS
  1. Go-To Rate

    The interest rate that will come into effect after an introductory ...
  2. Purchase Rate

    The interest rate applied to purchases made with a credit card.
  3. Negative Interest Rate Policy (NIRP)

    A negative interest rate policy (NIRP) is an unconventional monetary ...
  4. Nordic Model

    The social welfare and economic systems adopted by Nordic countries.
  5. Fee Harvesting Card

    Credit cards targeted at consumers with poor credit scores that ...
  6. Zero Percent

    A promotional rate of interest used to entice consumers, often ...

You May Also Like

Related Articles
  1. Economics

    Venezuela: Portrait of a Country in ...

  2. Trading Strategies

    Market Timing Tips & Rules You Should ...

  3. Economics

    Putin Says Russian Economy Healing - ...

  4. Economics

    How the UK Makes Money

  5. Economics

    Gambling on Macau: Too Risky?

Trading Center