The stock market is a fickle thing. Sometimes, it rises, sometimes it falls and these fluctuations are often confusing for the general public and novice investors alike. Keep reading as Douglas Battista shares insight on how interest rates affect the stock market.
Q: There are different kinds of interest rates. Which one has the greatest impact on the stock market?
Douglas Battista: The federal funds rate, which is also referred to as the overnight rate. The federal funds rate is the percentage that the Federal Reserve Bank charges depository institutions for money borrowed. The Federal Reserve adjusts this rate as a way to control inflation.
Q: How is this rate connected to the prime interest rate?
Douglas Batista: Banks pay close attention to the federal funds rate, which is one of the biggest factors that influence how much a bank charges consumers for credit. If the federal funds rate is low, credit card APR, mortgage loans, and other personal and business loans are less expensive. When the rate is high, these services cost more to consumers.
Q: What happens when the interest rate begins to rise?
Douglas Batista: An interest rate increase does not actually have a direct impact on the stock market. Rather, consumer reaction to a fluctuating interest-rate changes purchase behavior, which, in turn, affects the market. When interest-rates are high, consumers have less disposable income and buy less. This translates directly into decreased earnings for businesses, which almost always means lower stock prices.
Q: If one company’s stock takes a hit, can that impact the entire market?
Douglas Batista: Typically, no. However, fluctuating interest rates create a ripple effect. When one major company begins to see falling stock prices, others are often close behind. When enough companies see a decline, the key indexes – Dow Jones and the S&P 500 – see an overall decline as well.