As you are starting with your online stock trading adventure, you need to understand that interest rates can affect markets. It’s no different with stocks trading in the US exchanges. Any changes made to the rate of interest charged by banks for loans taken by customers, as well as the rate at which money is borrowed by banks, can be felt all through the economy. In the US, changes to the rate of interest are effected by the Federal Reserve Board (the Fed). These changes, or even anticipation of the changes, can cause inflation or recession and affect the stock and bond markets.
The Interest Rate-Economy Connection
As you know, interest is the rate at which banks lend money to customers that could be individuals or businesses. The higher the interest rate, the lesser is the amount of loan taken by the customers. Since the interest rate is high, businesses too will borrow less which will affect the investment they make on infrastructure and employee welfare, which in turn affects the productivity of the business. A similar situation for other businesses and industries can result in the economy slipping back.
On the other hand, a lower interest rate leads to more borrowing by individuals and businesses. This would increase spending on goods, infrastructure and employee wellbeing resulting in improved productivity, higher earnings and a boosted economy.
Fed Rate Determines Interest Rate for Loans
A higher interest rate is great for banks since they earn more on the loan they provide. But there is another factor which determines the interest banks charge customers for loans - the Fed rate for banks borrowing money from other banks. It’s also called the “federal funds rate.” This rate can change each day, and it affects the interest rate for all other loans that banks lend. The federal funds rate indicates whether other interest rates rise or fall.
Controlling Inflation and Recession
This Fed rate is used to control inflation and recession. If inflation is unchecked, goods and services will keep getting more and more expensive. While a certain level of inflation is an indication of a healthy economy, unchecked inflation could raise the prices of goods and services to unmanageable levels. This will, in turn, harm the economy again. The Fed raises the federal funds rate if the inflation keeps rising. This will increase the interest rates charged by banks for loans, which would cause people to spend lesser and lesser, and ultimately the prices will fall to manageable levels again. As demand drops, inflation falls.
Stock and Bond Prices
Interest rates that rise or fall do affect the spending of consumers and businesses. Rising interest rates cause consumers and businesses to reduce their spending, leading to earnings dropping for businesses, and stock prices falling. Falling interest rates result in businesses increasing spending, leading to greater earnings for businesses and the resultant rise in stock prices. Prices of bonds are also affected by interest rates, whereby increased rates of interest reduce bond prices while lower rates cause bond prices to rise. Bonds with longer maturity period are more susceptible to fluctuation in relation to interest rates.
Successful online stock trading requires in-depth understanding of this concept plus a clear view of the markets. That’s why TradeZero offers you sophisticated trading platforms for efficient trading. Call us at +1 954-944-3885, or email us at email@example.com.
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