There are lots of events happening across the globe at the moment. The most significant of these is the Russia-Ukraine war, which has created a huge effect on various sectors of the economy, including healthcare, energy, and more. The world was still reeling from the damaging effects of the global pandemic before the Ukraine invasion.
These events have caused ripple effects across the globe and all of us can see how interest rate impact the stock market. After all, we are living in a world of interconnected globalized economies. The primary consequence of these various events is rising inflation, as well as its impact on the economies. Take, for instance, with the rising inflation, it is not hard to find people who are working two, or three jobs just to keep pace with the increase in the prices of commodities.
With rising inflation, the Federal Reserve is also charged with making the economy “weaker”. They do so by increasing the interest rate, which reduces consumer spending capabilities by making it harder to borrow money. The dramatic, rising global inflation has prompted an aggressive interest rate hike from the Fed. This increased rate has effects on stock markets.
Federal Fund Rate: An Overview
Federal Fund Rate is the interest rate that banks and unions charge one another for overnight loans. This is in contrast to the discount rate, which is the interest rate that is charged by the Federal Reserve Banks whenever collateralized loans are made.
To control inflation, the Federal Reserve increases interest rates. When this rate is increased, what the Fed is trying to do is to effectively reduce the amount of money that is made available for consumers to make purchases, reducing their spending power in the process. This makes it harder for consumers and investors to borrow money.
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As Interest Rates Rise, What Happens?
The ongoing Russia-Ukraine war, as well as the ongoing pandemic, has resulted in global inflation, which is rising. To tackle this, the increase in the interest rate by the Federal Reserve must be aggressive, which is what is being done. However, the main question is: How does this interest rate surge affect the stock market?
As the Fed embarks on increasing the interest rate aggressively, what happens is that this immediately and effectively increases the cost of short-term borrowing for various financial institutions. With this, there is a ripple effect that is felt – in terms of borrowing costs – by companies and consumers in the economy.
Thanks to the fact that the costs of borrowing money are quite significant for financial institutions, they often charge their customers higher rates to borrow money from them. As consumers become affected by the surge in interest rates on mortgage and credit cards, it becomes harder for them to borrow money and the amount of money they spend reduces significantly.
It must also be noted that when consumers’ bills become more costly, they are left with less disposable income. As interest rates rise, businesses and companies are greatly impacted by reduced consumer demands (due to their affected spending capabilities) and higher borrowing costs. These can affect stock prices.
Since costs of borrowing increase as interest rate surges, stock investors are often more reluctant to invest or speculate on stock prices. After all, the value of future earnings will not be attractive, especially when compared to bonds that can offer more competitive yields.
Take, for instance, the start of the COVID-19 pandemic resulted in reduced economic activities across the globe and the stock market took a significant hit. In response, the Fed reduced the interest rate, making it easier for stock investors to borrow money. The stock market responded by storming back strongly.
The Fed will keep the economy running smoothly during this period of the pandemic, war, and other uncertainties. As inflation threatens to affect economic balance, interest rates will be increased aggressively to tackle consumer borrowing and spending habits. With this, stock investors will become more reluctant to invest. This will effectively produce an adverse effect on the stock market.