Do Interest Rates Affect The Stock Market? How and Why?

Do Interest Rates Affect The Stock Market?
Photo Credit: Tomorrowmakers

In recent months, there has been widespread fear that the world is staring at a serious recession. Investors around the world are retreating from risky assets such as stocks and cryptocurrencies amidst the rising interest rates. So this can make one wonder where and how the interest rates affect the stock market. Indeed, there is a connection between the central banks, interest rates, and the stock market.

This article will explain this for a better understanding of the interest rate and stock markets and more informed investments.

What Is the Difference Between the Stock Market Interest Rate?

In simple terms, the interest rate refers to the cost of borrowing. It is the percentage of the principal amount borrowed that the borrower has to pay to the lender. In other words, the interest rate impacts the cost of a loan.

In the United States, the Federal Reserve sets the interest rate. Banks set their interest rate in correspondence to the rate set by the Federal Reserve. Banks are at liberty to set their interest rates, so there is usually a disparity from one bank to another.

The stock market is where public companies’ shares are sold and bought. Stock exchanges facilitate the stock markets. For instance, the Japanese market is under the Japan Exchange Group (JPX) while the US has the New York Stock Exchange (NYSE). 

Interest Rates and the Stock Market in 2022

Just the other day, the US Federal Reserve increased the interest rate for the fourth time since March 2022 in a bid to contain the fastest inflation rate in four decades. The central bank is increasing the rate in a bid to make borrowing more costly, thus discouraging borrowing and slowing down spending and inflation.

The rise in interest rates is already impacting the stock market, but not as you might expect. In the US, stocks rose sharply even as the Fed broke the news of a 0.75% hike increase so how does the interest rate affect the stock market?

What Is the Relationship? 

Interest rates affects the stock market and how is it calculated? When the rates are lower, it might mean a greater likelihood of businesses borrowing to finance expansion. When the rates are higher, the likelihood of borrowing for expansion projects could be reduced, and instead, businesses could go for lower growth activities or even forfeit growth.

Often, the initial reaction of the stock market to interest rate change is anticipatory. Investors are trying to predict the effects of the interest rate in the market and so they trade according to these guesses. What happens is that opinion shapes the short-term reaction of the stock market.

That’s why it is not easy to tell what will happen in the stock market due to the changes in interest rates. One may argue that an increase in interest rates leads to falling stocks, but the recent state of the US market suggests otherwise.

A close analysis of the two elements reveals that interest rate hikes are not necessarily a bad thing. That’s because the rate hike affects different people differently. When the rates go up, some areas make a lot of money. A good example is the financial services sector, where higher rates can translate into higher margins.

Tech startups and similar growth stocks tend to suffer from the rising interest rates. This is because when the market becomes unpredictable, investors tend to prefer established companies.

From this explanation, it appears that stock market returns are not only dependent on the interest rate. That’s why financial experts will advise investors to spread their investments or go for diversified portfolios. This is the only way one can get returns in the long run, whether the interest rate rises or falls. 

To Wrap Up

At the moment when interest rates are on an upward trend, the best strategy is to assess your own circumstances, keeping expectations in check for the short term. However, if the rate hikes take control of inflation and the economy revives, the stock market is in a good position in the longer term.

For more tips on investing amidst rising interest rates, contact a reputable wealth consultant.

Do Interest Rates Affect The Stock Market FAQs

What is Interest rate?

In simple terms, interest rate refers to the cost of borrowing

What Is the Relationship between interest rates and the stock market?

Lower interest rates may lead more businesses to borrow to expand while high-interest rates may lead businesses to borrow less for development initiatives or perhaps avoid growth entirely.

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