The Federal Reserve has reduced the discount rate by 50 basis points while boosting the Federal Fund Target rate. This action did not halt the stock market's hemorrhaging. Raising interest rates should be bad for the stock market, but this has not been the case (Chien & Morris, 2017). The Federal Reserve hiking interest rates signals that the economy is expanding, which boosts stock values around the time the rates are announced. Higher growth compensates for the Federal Reserve's higher interest rates. The stock prices continued to rise despite the raising of the interest rates by the Reserve. It puts into question the notion that higher rates are harmful to the stock market (Chortareas & Noikokyris, 2017).
Treasury Bond Yields Reaction
In regards to the Treasury bond yields, the Federal Reserve’s decision on raising the rates may mean losses in the short-term. It is because the high rates tend to bring the bond prices down, which adjusts the market (Chortareas & Noikokyris, 2017). In the long run, the higher rates allow for reinvestment, which generates better returns. Changes in the monetary policy expectations in the market usually feed into the long-term bond yields as well as the country’s stock prices due to the discount factor. In most cases, the yield that is offered on a long-term bond is made up of the average of the current and the future short-term rates (Chien & Morris, 2017). It explains why the bonds follow a downward trend after the rates peak following declines in yields. However, in some cases, the stock market may increase. It is important to note that the bond yields are not closely tied to the Reserve’s rates due to their longer maturities, which means more can happen during their lifetime. The implication is that they have the potential to undergo big price changes.
Impact on Borrowers and Investors
Borrower and savers feel the impact of the rates hikes in equal measures. Borrowers will be required to pay more as a result of the higher rates with changes expected within the first 60 days. Home owners with mortgages will be expected to pay more when their loans are reset. On the other hand, savers will not get any benefits for a while as the rates hike (Chortareas & Noikokyris, 2017). The first group of borrowers to be affected is the credit card holders as well as those borrowers with home equity lines of credit. Companies tend to adjust to a new prime rate within the first 60 days after the release of the federal rates (Chien & Morris, 2017). Bank profits are expected to go up with the rise in the rates. For this reason, financial institutions have for a long time preferred higher rates as they are indications of a growing economy, and they can also increase their profit margins by charging consumers more in order to meet the federal rates.
Federal rate changes have global implications as well. When America raises rates, the impact is higher debt repayments for businesses and governments, as most of the amounts they owe debtors are denominated in dollars. The stronger the dollar, the cheaper it is for companies in regions such as Europe and Asia to export to the USA. Some of the markets around the world may react by increasing their rates as well (Chortareas & Noikokyris, 2017).
References
Chien, Y., & Morris, P. (2017). The rising federal funds rate in the current low long-term interest rate environment. Economic Synopses, (10), 1-2.
Chortareas, G., & Noikokyris, E. (2017). Federal Reserve policy, global equity markets, and the local monetary policy stance. Journal of Banking & Finance, 77, 317-327.
