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The second lesson of two on interest rates, why they are so important to the stock market and to traders and investors in the stock, futures, and forex markets with an introduction to the Federal Reserve.
In yesterday’s lesson we began our discussion on Monetary Policy with a look at one of its primary components, interest rates. In today’s lesson we are going to continue this discussion with another look at how interest rates affect the economy and therefore the markets, and by introducing the institution which implements Monetary Policy, the Federal Reserve.
As we saw in our example yesterday, small movements in interest rates can have dramatic effects on the economy. Just as small changes in interest rates can dramatically increase the costs for individuals to own a home or borrow money to purchase other goods, they can also have a dramatic affect on the cost of doing business.
It is for this reason that when interest rates rise, making borrowed money more costly, that people will also be less likely to start or expand a business. This not only has an effect on the business owner themselves but filters throughout the entire economy as less businesses being started and expanded means less jobs, which means less people getting paychecks, which means less people spending money and on and on down the line. The opposite is of course also true for when interest rates fall and business owners take advantage of access to cheaper borrowed money.
In addition to interest rates affecting the stock market, interest rates also have direct and indirect affects on the bond, foreign exchange, and futures markets. Here are a couple of quick examples of this which we will expand on in later lessons:
The Bond Market: When interest rates rise the value of existing bonds fall as investors can now purchase the same bond with a higher interest rate and vice versa.
The Forex Market: When Interest rates it becomes more attractive from a yield standpoint to own the dollar against other currencies or to invest in interest bearing dollar based assets. This creates a demand for dollars which will many times cause the dollar to strengthen. The reverse is also true when interest rates fall.
The Commodities Market: When economies grow at a greater rate as a result of lower interest rates this will mean a greater demand for commodities so their value will rise and vice versa.
Duration : 0:5:12
for #2, rising …
for #2, rising interest rates doesnt mean there is no demand for equities. But most economies in the world, which always look for safe heavens of their savings, will choose bonds over equities. Because it is not only giving you a fixed return but also assuring you the safegaurd of your notional amount, which is not predictable in equities. Again I say economies, but you are thinking from the individual point of view.
cheers
for your #1-rise in …
for your #1-rise in int rates makes the new bonds issued by the US govt more attractive. Thus demand shifts from equities to the safe heaven fixed income higher yeilding bonds. Also as existiing bonds which are yeilding lower than newly issued, obviously investor will go for the later one, lowering the price of current one.
hope this clears your doubt.
Nice work. keep it …
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I have 2 questions …
I have 2 questions for you.
1. You claim that a rise in interest rates result in a slide in the stock market AND a slide in existing bond prices. Don’t bond and stock prices move in opposite directions?
2. If a rise in interest rates results in a rise in the currency, does that capital inflow generally chase after debt instruments only and not equities?