What does a cut in interest rates mean for the stock market?

By Investopedia Staff AAA
A:

When the next Federal Reserve meeting is expected to bring interest rate cuts or increases, it is wise, as a stock investor, to be aware of the potential effects behind such decisions. Although the relationship between interest rates and the stock market is fairly indirect, the two tend to move in opposite directions. Here's why.

A decrease in interest rates means that those people who want to borrow money enjoy an interest rate cut. But this also means that those who are lending money, or buying securities such as bonds, have a decreased opportunity to make income from interest. If we assume investors are rational, a decrease in interest rates will prompt investors to move money away from the bond market to the equity market. At the same time, businesses will enjoy the ability to finance expansion at a cheaper rate, thereby increasing their future earnings potential, which, in turn, leads to higher stock prices. Investors and economists alike view lower interest rates as catalysts for expansion.

Overall, the unifying effect of an interest rate cut is the psychological effect it has on investors and consumers; they see it as a benefit to personal and corporate borrowing, which in turn leads to greater profits and an expanding economy.

For more information, see the article Forces Behind Interest Rates, and this tutorial on the Federal Reserve.

RELATED FAQS

  1. 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 ...
  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 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 ...
  4. What exactly is being done when shares are bought and sold?

    Most stocks are traded on physical or virtual exchanges. The New York Stock Exchange (NYSE), for example, is a physical exchange ...
RELATED TERMS
  1. Welfare Capitalism

    Definition of welfare capitalism.
  2. Bulldog Market

    A nickname for the foreign bond market of the United Kingdom. ...
  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 ...
comments powered by Disqus
Related Articles
  1. Understanding World Bank Data
    Investing

    Understanding World Bank Data

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

    India Is Eclipsing China's Economy As ...

  3. Decoding “Normal” Interest Rates
    Economics

    Decoding “Normal” Interest Rates

  4. The 5 Things You Never Knew About Auto ...
    Credit & Loans

    The 5 Things You Never Knew About Auto ...

  5. Saving Money Or Paying Off Debt?
    Credit & Loans

    Saving Money Or Paying Off Debt?

Trading Center