How Does Interest Rates Affect the Stock Market

In essence, interest is the amount paid for the usage of money borrowed. Some prime examples of interest is using a credit card or loaning a house. In terms of the stock market, however, the interest rate being referred to is the Federal Reserve’s funds rate or the cost of borrowing money from the Federal Reserve that is charged to the banks. The effects of this number to the stock market is staggering.

Basically, when the interest rates are cut by the Fed, the stock market is bullish while increases make the stock market bearish. However, several things factor in on the adjustment of the interest rate. The fed cannot simply cut the rates to boost the market because the economy will become inflated or overheat.

Decreasing the interest rate is done by the Federal Reserve when the economy is slowing down. This is done to stimulate financial activity as investors will be attracted to invest. The lowered rates will help in offsetting a weakening economy thus pulling down stock prices with it. Once the economy is no longer slowing, the Fed will usually increase the interest rates. Despite the higher rates and the increased stock prices, investors won’t be deterred in investing on a stable economy. This will bring more financial activity and boost the economy.

Maintaining the balance is essential to keep the economy growing. The interest rates act as a tool to keep the economy stable.