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How Interest Rates Affect the Stock Market

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Interest rates: they affect nearly every aspect of our lives.

Whether we’re buying a house, or paying off credit cards, we need to keep an eye on interest rates to make sure our money goes as far as it can.

But interest rates can affect the stock market, too.

Even if you haven’t invested in any stocks, the link between interest rates and the stock market can impact your life.

Read on to find out how.

What is Interest?

  • Interest is simply the fee you pay to use someone else’s money.
  • Institutions like banks and other types of lenders charge interest.
  • Sometimes, bank customers can earn interest on certain accounts, usually savings accounts or a certificate of deposit (more commonly known as a CD).
  • Interest rates are typically calculated as a percentage.
  • Interest rates can fluctuate depending on some economic factors.
  • Essentially, interest rates are a way to compensate an institution or individual for taking the risk of lending money.

How Does Interest Work in the Stock Market?

Most people are familiar with interest rates due to their mortgages and credit card bills.

But interest works a little differently when it comes to the stock market.

The Federal Reserve’s funds rate is the interest that banks and credit unions pay to borrow money from Federal Reserve banks.

This rate is set approximately every six weeks, during meetings held by the Federal Open Market Committee (FOMC).

interest rates 1

Figure 1: History of The Federal Funds Rate

The Federal Reserve, or the “Fed”, uses this interest rate to keep inflation in check.

(Inflation is caused by a simultaneous increase in prices and a decrease in the purchasing value of money.)

It does this by controlling the amount and worth of money available to purchase goods.

In theory, when the Fed increases the federal funds rate, the amount of money in circulation will decrease, while the price to borrow it will increase.

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What Happens When the Federal Rate Increases?

An increase in the federal funds rate will not immediately affect the stock market. 

The primary result of increase is the expected one: banks have to pay more to borrow from the Fed.

That’s essentially the first effect of any increase in interest rates.

interest rates 2

Figure 2: Estimated rate increase patterns in 2015, despite wage growth and a high employment rate (Business Insider)

The consequences of an increase might not be immediately evident in the stock market, but they can have a ripple effect on individual consumers and businesses alike very quickly.

Here’s how:

  1. Banks will first have to increase their interest rates since they now have to pay more to access the money they lend to their customers.
  2. Both mortgage and credit card interest rates will increase. This is especially unfortunate for homeowners or other types of borrowers who have variable interest rates.
  3. As a result, consumers will have less disposable income, causing them to decrease their discretionary spending.
  4. The decline in spending will directly affect companies’ revenue, potentially resulting in a drop in profit.
  5. Let’s not forget businesses borrow money from banks, too – when the rate increases, companies are less likely to borrow and will also lose money by paying the higher rate.
  6. Businesses will then have less money to spend and will, therefore, spend less; a decrease in spending can often impede the growth of a company.
  7. When a company cannot grow, it cannot increase profits.

How Does the Increase Affect the Stock Market?

Of course, increasing the federal funds rate will immediately and directly influence the way consumers and businesses spend their money. 

Those changes in spending are what will eventually affect the stock market.

One way of appraising a company is by determining the sum of that company’s expected future cash flows, discounted back to the present.

In order to calculate a stock’s price, find the sum of the future discounted cash flow and divide that value by the number of shares available.

People’s assumptions about or attitudes toward the company can also influence that price at a given time.

Depending on the correlation between the two, consumers might be more or less willing to invest at different prices.

If a business has decreased spending or is earning less profit, the likely consequence is that their expected future cash flows will drop.

Assuming all other financial aspects of the company are equal, the price of the company’s stock will decline as a result.

If several businesses experience these decreases, the whole market is at risk of going down.

How Does this Affect Investment?

No investor wants the market to go down; they want to watch their investments accrue value rather than lose it.

That’s one of the primary reasons they invest in the market in the first place.

Stock price appreciation and payment of dividends help investments gain value. 

When an increase in the federal rate hinders a company’s ability to grow, investments will not grow as much from stock price appreciation.

If investments stop growing, people will be more reluctant to invest.

Owning stocks could also be considered riskier when the rate goes up.

Government securities like Treasury bills and bonds are considered safer investments when the Federal funds rate increases.

Their interest rates will rise also.

However, because the “risk-free” rate of return increases, these types of investments are considered more beneficial during times of increased interest rates.

When traders invest, it’s important that they are compensated for the extra risk they are taking by making the investment – a premium above the risk-free rate.

The ideal return for investing is determined by taking the sum of the risk-free rate and the risk premium.

Investors’ risk premiums vary, depending on the companies they invest in, and how much they are willing to risk.

When the risk-free rate goes up, the result is an increase in the total return needed to invest.

A lower risk premium and a stable or decreased potential return might lead investors to surmise that the stock market has become risky.

Summing Up: The Fed Rate, the Stock Market, and You

The Federal Reserve interest rate has a profound influence on the economy:

  • When the rate increases, there is less money in circulation.
  • Though this helps to lower inflation, it causes borrowing to become more expensive.
  • When borrowing is more expensive, it directly impacts how much money consumers and businesses have to spend.
  • This results in a change in both consumer and business spending habits.
  • Higher rates increase expenses for businesses, which could potentially result in a business decreasing wages to make up for the lost funds.
  • People are less likely to want to invest in the market when rates are higher.
  • So, basically decreased investments result in decrease of people investing, which in turn affect the rates

However, it is important to remember that the stock market is not a static system.

The description provided above serves to explain the phenomenon in theory.

In practice, the effects of the interest rate on the stock market might not be so clear cut.

interest rates 3

Figure 3: An example of a positive relationship between the Fed rate and the stock market

Stock values fluctuate according to many factors besides the federal interest rate.

Several aspects play a role in determining stock prices, and the interest rate is only one of many of them.

Because of this, an investor can never be sure if an increase in the federal rate will hinder (or possibly help) the stock market.

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Economy

STUDY: Number of Billionaires Doubles in Last Decade

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Number of Billionaires Doubles in Last Decade
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The number of billionaires has doubled in the past decade and the world’s wealthiest 2,153 people controlled more money than the poorest 4.6 billion combined last year, the charity Oxfam said Monday.

Meanwhile, unpaid or underpaid work by women and girls adds three times more to the world’s economy each year at least $10.8 trillion than the technology industry, the Nairobi-based charity said in its “Time to Care” report.

Women around the world work 12.5 billion hours combined each day without any pay or recognition, while the world’s 22 richest men have more wealth than all the women in Africa.

“It is important for us to underscore that the hidden engine of the economy that we see is really the unpaid care work of women. And that needs to change,” Amitabh Behar, CEO of Oxfam India, told Reuters.

“Our broken economies are lining the pockets of billionaires and big business at the expense of ordinary men and women. No wonder people are starting to question whether billionaires should even exist,” Behar said ahead of the annual World Economic Forum in Davos, where he will represent Oxfam beginning Tuesday.

“Women and girls are among those who benefit least from today’s economic system,” he added.

There will be at least 119 billionaires worth about $500 billion attending Davos this year, according to Bloomberg, with the highest contingents coming from the US, India and Russia.

“The very top of the economic pyramid sees trillions of dollars of wealth in the hands of a very small group of people, predominantly men,” the Oxfam report said.

“Their wealth is already extreme, and our broken economy concentrates more and more wealth into these few hands,” it said.

To highlight the inequality, Behar cited the case of a woman called Buchu Devi in India who spends up to 17 hours a day walking almost two miles to fetch water, cooking, preparing her kids for school and working in a poorly paid job.

“And on the one hand you see the billionaires who are all assembling at Davos with their personal planes, personal jets, super rich lifestyles,” he said.

“This Buchu Devi is not one person. I in India encounter these women on a daily basis, and this is the story across the world. We need to change this, and certainly end this billionaire boom.”

Behar said that to remedy the problem, governments should make sure above all that the rich pay their taxes, which should be used to pay for amenities such as clean water, health care and better schools.

“If you just look around the world, more than 30 countries are seeing protests. People are on the street and what are they saying? That they are not to accept this inequality, they are not going to live with these kind of conditions,” he said.

Source: New York Post
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(c) 2020 2019 Vanguard Media Limited, Nigeria Provided by SyndiGate Media Inc. (Syndigate.info).

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Automobiles

Pump Prices to Edge up After Attack on Iranian General, but Long-Term Effect Unclear

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By Jeff Ostrowski, The Palm Beach Post, Fla.

Motorists soon will see the effects of President Donald Trump’s decision to kill a prominent Iranian general. Whether pump prices rise a little or a lot depends on how quickly international tensions intensify.

Florida gas prices climbed an average of 7 cents a gallon in the past three days and could increase an additional 5 cents, AAA – The Auto Club Group said Monday.

The 7-cent increase was coming even before the U.S. air strike Thursday that killed Iranian Maj. Gen. Qassem Soleimani. That hike was a result of a rise in the price of crude oil in December.

News of the targeted killing of Soleimani sent crude oil surging nearly $2 per barrel on Friday. An increase of that magnitude typically translates to a 5-cent hike at the pump, AAA said.

The U.S. benchmark for crude oil traded Monday just above $63 per barrel, the highest level since May 2019. The price of oil makes up about half the price of a gallon of gas.

“What happens in the Middle East can have a direct impact on Americans’ daily lives by influencing what they pay at the pump,” said AAA spokesman Mark Jenkins. “Crude prices rise when there’s a threat of war, because of concerns over how the conflict could hamper supply and demand.”

Oil analyst Tom Kloza of energy firm OPIS agreed that pump prices in Florida likely will rise about 5 cents a gallon in the coming days.

“Then I have a hunch that things are going to calm down,” Kloza said Monday. “I don’t think we’re looking at $3 gas.”

The national average pump price Sunday was $2.585, while the Florida average was $2.526, AAA said.

Kloza expects only modest increases in part because of the timing of the attack. January is always a slow month for gas consumption in the United States.

There’s also the reality that sanctions leave Iran unable to export oil. Complicating the calculus is Iraq’s response to the U.S. attack. The drone strike on Soleimani took place in Baghdad, and some Iraqi politicians considered the assault an affront to Iraqi sovereignty.

While there’s no Iranian oil supply to be disrupted by a war, Iraq is an important producer.

Trump keenly watches oil prices and realizes that a price spike might erode his support in this year’s presidential election, Kloza said.

At the same time, Kloza added, “This president has proven to be unpredictable.”

Trump’s response has been typically uneven. Delivering an official statement at the Mar-a-Lago Club in Palm Beach, Trump’s tone was measured. He said the targeted killing was designed to pre-empt Soleimani’s planned attacks on American diplomats and soldiers.

“We took action last night to stop a war,” Trump said Friday. “We did not take action to start a war.”

However, over the weekend, Trump took to Twitter to threaten attacks on Iranian cultural sites.

“The United States just spent Two Trillion Dollars on Military Equipment,” Trump wrote Sunday on Twitter. “We are the biggest and by far the BEST in the World! If Iran attacks an American Base, or any American, we will be sending some of that brand new beautiful equipment their way…and without hesitation!”

##IFRAME_1##Iran has vowed vengeance, but military experts say the nation isn’t powerful enough to wage a direct war against the U.S.

“It’s still far too early to know how much of an impact this conflict will have overall on prices at the pump,” AAA’s Jenkins said.

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Economy

Stocks Rally Despite Impeachment News

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Stocks rose on Thursday as investors looked past the news of President Donald Trump’s impeachment as well as mixed U.S. economic data.

The Dow Jones Industrials advanced 53.85 points to begin trading at 28.293.13

The S&P 500 recovered 4.93 points to 3,196.07

The NASDAQ added 19.39 points to Wednesday’s all-time record, at 8,847.12.

The S&P 500 is up nearly 7% since House Speaker Nancy Pelosi launched a formal impeachment inquiry in September.

Cisco Systems was the best-performing Dow component, rising 1.6%. The consumer staples and real estate sectors led the S&P 500 higher, gaining 0.4% each. Micron Technology shares also contributed to Thursday’s move higher. Conagra shares surged more than 14% and were on pace for their biggest one-day gain since Oct. 16, 1989.

Micron shares climbed 3.5% on the back of strong quarterly results. The chipmaker posted earnings per share and revenue that topped analyst expectations.

On the economic data front, weekly jobless claims fell to 234,000 from 252,000 the week before. However, economists expected claims to fall to 225,000.

Meanwhile, the Philadelphia Federal Reserve’s business conditions index fell to 0.3 in December from 10.4 in the previous month. Economists expected the index to slip to 8.

The Democrat-led House of Representatives voted Wednesday to impeach Trump for abuse of power and obstruction of Congress. Trump became only the third president to be charged with high crimes and misdemeanors and will now face a trial in the Republican-controlled Senate.

Prices for the 10-Year U.S. Treasury were lower, raising yields to 1.94% from Wednesday’s 1.93%. Treasury prices and yields move in opposite directions.

Oil prices gained seven cents to $61.00 U.S. a barrel.

Gold prices moved forward $1.80 at $1,480.50 U.S. an ounce. Copyright © 2019 Baystreet.ca Media Corp. All rights reserved.

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