The economy runs like a machine. Right now, it’s overheating: Inflation levels are at the highest in decades, with prices climbing on everything from groceries to cars to rent.
The financial system includes everything from the stock market to the banking sector to the wonky, technical products that make up the plumbing of the global economy. Changes in the federal funds rate influence those markets in the United States and abroad.
Bond traders, Wall Street bankers and market analysts all try to anticipate the Fed’s next moves. That amplifies the effect of interest rate increases and the central bank’s public messaging. Analysts might scrutinize Fed speeches in hopes of gleaning any hints on the exact size of the next interest rate hike, so the markets can start pricing in those moves ahead of time. The value of some financial instruments is also influenced by changes in the Fed’s overnight rate.
When rates go up, it becomes more expensive for businesses to borrow money. That can hurt future growth and weigh on a company’s stock performance. If enough companies see their stock prices go down, the whole market can sink. And as rates go up, risky stocks can seem less attractive because investors can make more money in safer assets than they can with low interest rates.
Meanwhile, bonds and interest rates have an inverse relationship. If interest rates go up, bond prices fall, and vice versa. Many bonds pay a fixed interest rate that’s more desirable if interest rates are going down, since demand for bonds usually rises then, along with their price.
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