Best of the Week
Most Popular
1. Crude Oil and Water: How Climate Change is Threatening our Two Most Precious Commodities - Richard_Mills
2.The Potential $54 Trillion Cost Of The Fed's Planned Interest Rate Increases - Dan_Amerman
3.Best Cash ISA Savings for Rising UK Interest Rates and High Inflation - March 2018 - Nadeem_Walayat
4.Fed Interest Hikes, US Dollar, and Gold - Zeal_LLC
5.What Happens Next after February’s Stock Market Selloff - Troy_Bombardia
6.The 'Beast from the East' UK Extreme Snow Weather - Sheffield Day 2 - N_Walayat
7.Currencies Will Be ‘Flushed Down the Toilet’ Triggering a ‘Mad Rush into Gold’ - MoneyMetals
8.Significant Decline In Stocks On The Cards! -Enda_Glynn
9.Land Rover Discovery Sport Extreme Driving "Beast from the East" Snow Weather Test - N_Walayat
10.SILVER Large Specualtors Net Short Position 15 Year Anniversary - Clive_Maund
Last 7 days
Can Bitcoin Price Rally Continue After Paypal Fake FUD Attack? - 19th Mar 18
2018 Reversal Dates for Gold, Silver and Gold Stocks - 19th Mar 18
This Tech Breakthrough Could Save The Electric Car Market - 19th Mar 18
Stocks Set to Open Lower, Should You Buy? - 19th Mar 18
The Wealth Machine That Rising Interest Rates Create Conflict With The National Debt - 19th Mar 18
Affiliate Marketing Tips and Network Recommendations - 19th Mar 18
Do Stocks Bull Market Tops Need Breadth Divergences? - 19th Mar 18
Doritos Instant £500 Win! Why Super Market Shelves are Empty - 19th Mar 18
Bonds, Inflation & the Market Amigos - 19th Mar 18
US Housing Real Estate Market and Banking Pressures Are Building - 19th Mar 18
Stock Market Bulls Last Stand? - 18th Mar 18
Putin Flip-Flops Like A Drunken Whore On Bitcoin Cryptocurrency Legalization - 18th Mar 18
How to Legally Manipulate Interest Rates - 18th Mar 18
Return of Stock Market Volatility Amidst Political Chaos and Uncertain Economy - 18th Mar 18
Bitcoin Price Trend Forecast, Paypal FUD Fake Cryptocurrency Warning - 17th Mar 18
Strong Earnings Growth is Bullish for Stocks - 17th Mar 18
The War on the Post Office - 17th Mar 18
GDX Gold Mining Stocks Fundamentals - 16th Mar 18
Nationalism, Not the Russians, got Trump Elected - 16th Mar 18
Has Bitcoin Bought It? - 16th Mar 18
Crude Oil Price – Who Wants the Triangle? - 16th Mar 18
PayPal Cease Trading Crypto Currency Bitcoin Warning Email Sophisticated Fake Scam? - 16th Mar 18
EUR/USD – Something Old, Something New and… Something Blue - 16th Mar 18
DasCoin: A 5-Minute Guide to How It Works - 15th Mar 18
Stock Market Downward Pressure Mounting - 15th Mar 18
The Stock Market Trend is Your Friend ’til the Very End - 15th Mar 18
6 Easy Ways to Get What Women Want, for Less! - 15th Mar 18
This Isn’t Your Grandfather’s (1960s) Inflation Scare - 15th Mar 18
Eye Opening Stock Market Index, Volatility, Charts and Predictions - 15th Mar 18
Gold Cup At Cheltenham – Gold Is For Winners, Not For Gamblers - 15th Mar 18
Upcoming Turnaround in Gold - 14th Mar 18
Will the Stock Market Make Another Correction this Year? - 14th Mar 18
4 Ways To Writing An Interesting Education Research Paper - 14th Mar 18
China Toward Sustainable Economic Growth - 14th Mar 18
Stock Market Direction Is No Longer Important - 14th Mar 18
Trade Tariffs Defeat Globalists and Return Prosperity - 14th Mar 18
Stock Market Crash is Underway and Cannot be Stopped! - 14th Mar 18
Are Energy Sector Stocks Bottoming? - 14th Mar 18
Nasdaq Stocks Soars to New Record High After Strong Job Reports - 14th Mar 18
Bitcoin BTCUSD Elliott Wave View Calling for Rally toward $15,000 - 13th Mar 18
Hungary’s Gold Repatriation Adds To Growing Protest Against US Dollar Hegemony - 13th Mar 18
Record Low Volatility in Precious Metals and What it Means - 13th Mar 18
Tips for Writing and Assembling the Classification Essay - 13th Mar 18
Gerald Celente "If Rates go up too High, the Economy goes Down, End of Story" - 13th Mar 18
Stock Market Selloff Showed Gold Can Reduce Portfolio Risk  - 13th Mar 18
Silver Does it Again! Severe Consequences - 12th Mar 18
Has the Stock Market Rally Run Out of Steam? - 12th Mar 18
S&P 500 at 2,800 Again, Stock Market Breakout or Fakeout? - 12th Mar 18
The No.1 Energy Stock To Buy Right Now - 12th Mar 18
What Happens Next When Stock Market Investor Sentiment is Neutral - 12th Mar 18
Economic Pressures To Driving Gold and Silver Prices Higher Long-Term - 12th Mar 18
Labour Sheffield City Councils Secret Plan to Fell 50% of Street Trees Exposed! - 12th Mar 18

Market Oracle FREE Newsletter

Urgent Stock Market Message

Do Stock Market Investors Really Want The Fed to Lower US Interest Rates?

Stock-Markets / US Stock Markets Sep 06, 2007 - 02:02 PM GMT

By: Hans_Wagner

Stock-Markets Best Financial Markets Analysis ArticleInvestors trying to beat the market are closely following the trends in interest rates, especially the Federal Funds Rates. With many of the market traders and talking heads calling for a cut in the Fed Funds rate, do investors follow their advice or make their own assessment. Let's look at what the theory says about the link of interest rates and the market. Next we will look at the impact of inflation will have on rates and finally a chart that compares Fed Funds rates, the 3 month Treasury Rate and the S&P 500. 

The Theory

In theory changes in interest rates and movements in the stock market move in opposite directions. Assuming investors are rational people, when interest rates decrease should encourage them to move money from the bond market to the stock market, as bonds will be returning less as rates are lower. Also, businesses will be able to borrow at lower rates to finance growth and expansion, which should lead to future growth and as a result higher stock prices.

The other effect a cut in interest rates is psychological. Investors and consumers see lower interest rates a sign that they can borrow more cheaply, meaning they can spend more. This in turn should contribute to higher corporate profits, expansion of the economy and therefore higher stock prices.

The discounted cash flow model is one method used to value securities. This approach takes the sum of all expected future cash flows from a company and discounts them at a capital value rate to derive the current value. To obtain the stock price one takes the sum of future discounted cash flows and divides this value by the number of shares available.

Using this method and investor can compare the return on two investments; let's say a treasury bond and a stock. If the money they get from bonds is less than the money they get from the stock they should buy the stock. On the other hand if the money they get from bonds is greater than the bond then they should buy the bonds.

Basically the higher the interest rate, the lower will be the value and therefore the price of a payment in the future. A rise in the interest rate causes stock prices to fall. And a fall in interest rates causes the price of a stock to rise.

The complete theory is more complex and detailed.

The Reality

According the latest release from the Bureau of Economic Analysis (July 31, 2007) Personal Consumption Expenditures (PCE), supposed to be the Federal Reserve's favorite inflation indicator, was 2.1% for the year. This is just above the rumored Federal Reserve's target inflation range of 1 – 2%. For reference the table below shows the PCE rate for the last eight months. It has been decreasing since May 2007, though it has remained in a 2.1 – 2.6 range. So inflation is not yet within the Fed's desired range, though it is close. 

Price Index for Personal consumption Expenditures: Percent Change from Month One Year Ago

Month Dec 06 Jan 07 Feb 07 Mar 07 Apr 07 May 07 Jun 07 Jul 07
PCE 2.3 2.1 2.3 2.6 2.3 2.4 2.3 2.1

Source: Bureau of Economic Analysis Press release (July 31, 2007)

The August 17, 2007 Point of Interest discussed how the Fed faces a series of difficult months ahead on the inflation front. This seems to imply that the Fed is not yet ready to lower the Fed Funds rate, even if the market says it must have a lower rate. 

Now let's look at what has happened in the past to the market when the Fed has changed the Fed Funds rate. The chart below is a weekly chart of the S&P 500 beginning in 1990 to the present. The top part of the chart shows the US Treasury 30 month bill rate and the Fed Funds rate. The data on the Treasury Bill rate only went back to 1990, so that is where I started the chart. Take a few moments to look over the chart.

A couple of observations. From 1990 to 1993 the theory that when interest rates go down the market goes up worked. In 1994 rates went up, with the Fed Funds rate leading the way and the market was basically flat. The theory worked again. Starting in 1995 rates went sideways to slightly down and the market move up in a very nice bull market. Starting with the middle of 1998 the Federal Funds rate started to climb and the market experience a strong pull back from just below 1200 to the 950 area. Then the market moved up to finish 1999 much higher. Meanwhile Fed Funds rates and the short term 3 month treasury rate climbed. As everyone knows the market peaked in early 2000. Up until then the theory that when rates moved up the market went down held. The rise in rates in 1999 did not result in a corresponding fall in the market until the first half of 2000.

Starting in 2000 interest rates were lowered dramatically to help deal with the economic slow down. The market fell as well, with the 3 month Treasury Bill rate following behind. As shown Federal Fund rates eventually reached the one percent level, where they remained for about a year. In July 2003 the Fed began to raise the Fed Funds rate over the next two years, reaching the current level of 5.25 percent. The market also began its most recent bull market run in early 2003. So in this case the theory did not follow as rates rose and so did the market. But then rates were considered to be to low by many which helped the economy expand, causing the market to rise. In this case the theory did not work.

This leaves us with the question, if the Fed lowers interest rates, will the market go up? According to the theory, the answer is yes. However, what if the reason the Fed lowers rates is because the U.S. economy is perceived to be going into a recession, rather than just slowing down. I suspect if investors realize this is the case, then the market will fall rather than rise. As happened in 2000, when the economy's growth rate was negative the market also fell. Yes, it was at an extremely high level, but an economy that is experiencing negative growth is not conducive to a stock market that is expanding.

If the Federal Reserve does not lower rates on September 18, 2007, investors need to understand why rather than just throw in the towel and give up. They may be seeing cont9inued economic growth and they are still worried about inflation. The economic news so far is mixed with Gross Domestic Product in the second quarter up a revised 4% and retail sales are stronger than expected. The latest Federal Reserve Beige report did not provide sufficient economic data to support a rate cut, causing the market to fall after it was released. However, the housing sector is still falling as credit problems continue and sales of new and existing homes continue to drop.

On Friday, September 7, 2007, the Labor Department reports on jobs and salaries, a key insight into consumer spending, which makes up 70 percent of the U.S. economy. This will be an important indicator, especially if it surprises either to the up side or down side. It will also be important to monitor what the Federal Reserve members say in various speeches before they meet in September.

For more information on the linkage of interest rates and the market check out Economic Growth by David Weil. An easy to read book that presents the key factors to understand global economies. It is expensive and is used as a text book for college students, but it is worth the money.

The Bottom Line

Investors need to be careful as they might get what they wish, a lower Fed Funds rate. While many believe it is good for the stock market, it is also a sign that the economy is weaker than expected, possibly indicating a recession is near. As long as the Fed believes the economy is not slowing too much, then I expect the Fed funds rate to remain at 5.25% until there are clear signs that inflation is under control. Beside the market is already factoring in an interest rate cut. If they get one, it is unlikely to move the markets very much, unless the Fed changes its focus. For now investors need to be very careful as there is more down side risk in the market.

By Hans Wagner

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at

Hans Wagner Archive

© 2005-2018 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


06 Sep 07, 19:13
Stock Index opening

At the daily opening of the stock market in Hong Kong per say what component is used in deciding a higher or lower index opening and how is this calculated. Please advise. thank you

Shravan Kumar
14 Sep 07, 02:46
Fed interest rates!

I am from India and there is feed back from friends in USA that FED may not only cut the interest rates but there is strong possibilty that FED may increse the rates to 5.50%


Shravan Kumar

Jaipur (India)

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules