Interest rates can have a huge impact on the price that investors are willing to pay for different asset classes. For example, if interest rates are high, investors tend to favor lower risk, high yield investments like bonds over stocks and vice versa.
"What's happening wit
interest Rate?" "Where's The Prime headed?" "Is
the Fed announcing a rate hike next month?"
Interest
rates, the cost someone pays for the use of someone else's money, tend to
obsess the investment community and the financial media – and with good reason.
When (FOMC) sets the target for the Federal funds rate at
which banks borrow from and lend to each other, it has a ripple effect across
the entire U.S. economy, not to mention the U.S. stock market. And, while it
usually takes at least 12 months for any increase or decrease in interest rates
to be felt in a widespread economic way, the market's response to a change (or
the news of a change) is often more immediate.
The interest rate that moves markets is the federal funds rate. Also known as the overnight rate this is the cost that depository institutions are charged for borrowing money from faderal reserve banks – an inter-bank loan rate so to speak.
The federal funds rate is the way the Fed attempts to control inflation (an increase in prices, caused by too much money chasing too few goods: demand outstripping supply). Basically, by increasing the federal funds rate, the Fed attempts to shrink the supply of money available for purchasing or doing things, by making money more expensive to obtain. Conversely, when it decreases the federal funds rate, the Fed is increasing the money supply and, by making it cheaper to borrow, encouraging spending. Other countries' central bank do the same thing for the same reason.
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