“Understanding the relationship between Fed Fund rates and the stock market will help you understand how changes may impact investments”— Paul Ebeling
The interest rate that impacts the stock market is the federal funds rate. The federal funds rate is the interest rate that depository institutions: banks, savings and loans, and credit unions charge each other for overnight loans, whereas the discount rate is the interest rate that Federal Reserve Banks charge when they make collateralized loans usually overnight to depository institutions.
The Fed influences the federal funds rate in order to control inflation. By increasing the federal funds rate, the Fed is effectively attempting to shrink the supply of money available for making purchases. This makes money more expensive to obtain.
Conversely, when the Fed decreases the federal funds rate, it increases the money supply. This encourages spending by making it cheaper to borrow. The central banks of other countries follow similar patterns.
The federal funds rate is significant because the prime interest rate is largely based on the federal funds rate. It also forms the basis for mortgage loan rates, credit card APRs, and lots of other consumer and business loan rates.
Interest Rates and the Stock Market
If a company is seen as cutting back on its growth or is less profitable the estimated amount of future cash flows will drop. This will lower the price of the company’s stock
If enough companies experience declines in their stock prices, the Key indexes many people equate with the market: the Dow Jones Industrial Average, S&P 500, NAS Comp and Russell 2000 will go down. With a lowered expectation in the growth and future cash flows of a company, investors will not get as much growth from stock price appreciation. This can make stock ownership less desirable.
But, some sectors benefit from interest rate hikes. The sector that tends to benefit the most is the financial industry. Banks, brokerages, mortgage companies, and insurance companies’ earnings often increase as interest rates move higher because they can charge more for lending and these are the sectors that will lead the next leg up in this market’s V shaped recover off of the recent lows.
Rising or falling interest rates impact the psychology of investors. When the Fed jawbones hawkishily, both businesses and consumers will will act cautiously. And stock prices to drop in anticipation as it did on 5 April.
On the other hand, when the Fed announces a cut, the assumption is consumers and businesses will increase spending and investment. This can cause stock prices to rise.
Interest rates and Cryptocurrencies
Central bankers and US lawmakers have for yrs bemoaned the rise of stablecoins, a specific subset of cryptocurrencies that have a value pegged to a real-world asset, such as a fiat currency like the USD or a commodity/currency like gold.
These nongovernmental digital tokens are increasingly being used in domestic and international transactions, which is scary for central banks because they do not have a say in how this sector is regulated.
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Have a prosperous day, Keep the Faith!