How interest rates move stock prices
Why stocks often fall when interest rates rise, and rise when rates fall. Three plain reasons, with no jargon.
Markets react to almost every word from the US Federal Reserve and the Bank of Canada. The reason is interest rates. Here is why rates matter so much to share prices.
Reason 1: borrowing costs
When interest rates rise, borrowing costs more. Companies pay more on their loans. Shoppers borrow less for houses and cars. Both can mean lower profits ahead, and share prices follow expected profits.
When rates fall, the reverse happens. Cheaper loans can help businesses grow and people spend.
Reason 2: safer choices pay more
When rates are high, savings accounts and government bonds pay more. Some investors decide a safe, steady return is good enough and move money out of stocks. Less demand for stocks can mean lower prices.
Reason 3: future profits are worth less today
Investors value a company by what it is expected to earn over many years. Higher rates make money earned far in the future worth less today, because money in hand could earn more interest in the meantime.
This hits fast-growing companies hardest, since most of their expected profit is years away. It is one reason technology stocks often swing more than banks or utilities when rates change.
Why the market moves before rates do
Central banks change rates on set dates. Markets move earlier, as soon as investors expect a change. A rate cut that everyone expected can cause no move at all on the day. A surprise can cause a big one.
The short version
- Higher rates make borrowing cost more and can slow profits.
- Higher rates make safe savings more attractive than stocks.
- Higher rates shrink the value of profits expected far in the future.
- Markets react to expected changes, not just actual ones.
This is general information, not investment advice.
Updated