Video Lesson
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The Federal Reserve and Interest Rates
The Federal Reserve sets the federal funds rate — the benchmark for borrowing costs throughout the economy. Rate hikes slow the economy; rate cuts stimulate it. Markets react strongly to both actual rate changes and Fed guidance about future moves.
Why Rising Rates Hurt Stock Prices
- Higher rates increase borrowing costs, compressing corporate profits
- Future earnings are discounted at a higher rate, reducing present value
- Bonds become more attractive relative to stocks
- Growth stocks are hit hardest — their value depends on distant future cash flows
Why Falling Rates Boost Stock Prices
- Cheaper borrowing fuels corporate expansion and share buybacks
- Future earnings are discounted at a lower rate, raising valuations
- Investors rotate from bonds back into equities
- Growth and technology stocks benefit most
The Yield Curve as a Signal
The yield curve shows the relationship between short-term and long-term interest rates. When it inverts — short-term rates exceeding long-term rates — it has preceded every US recession since 1955. Watch the spread between the 2-year and 10-year Treasury yields as a key macro indicator.
Practical Takeaways
Don't try to time the market around Fed announcements. Instead, understand that rising rate environments tend to favor value stocks and financials, while falling rate environments benefit growth stocks and REITs. Stay diversified and let the fundamentals guide your decisions.