Interest rates

S

stockoptionstrader

Hi,

Can someone explain what interest rates mean?

I often see the terms rate hike and cutting rates, what does it actually mean for the stock market? Do stocks go up when they are cutting rates?

I think rate hike means making interest rates higher?

Cutting rates is to diminish the interest rates?

I'm asking because I'm not a native english speaker and the words they use are confusing to me.

TIA
 
Yes, the jargon can be tricky.

In the context of Federal Reserve Interest Rates, they mean the rate banks charge when they loan to each other. The Federal Reserve sets this rate, and It's not the same interest rates that you get on, say, a home mortgage. Raising these rates makes money more expensive, and has a dampening, braking effect on many areas of the economy.

- "Rate Hike" means a raise in rates, usually 0.25% at a time. Think of hiking up a hill, step by step.
- "Cutting Rates" means reducing interest rates, again, usually by 0.25% at a time.

Along the same lines,
"Dovish Statements" means language that doesn't really indicate a rate hike.
"Hawkish Statements" means language that more strongly points to a rate hike.

So, you could say that today, they raised rates 0.25%, and made hawkish statements about not two, but three more rate increases in 2017. Should this happen, it would constitute a rate hike.

Here is an excellent video on the topic:
 
kmiklas said:
Yes, the jargon can be tricky.

In the context of Federal Reserve Interest Rates, they mean the rate banks charge when they loan to each other. The Federal Reserve sets this rate, and It's not the same interest rates that you get on, say, a home mortgage. Raising these rates makes money more expensive, and has a dampening, braking effect on many areas of the economy.

- "Rate Hike" means a raise in rates, usually 0.25% at a time. Think of hiking up a hill, step by step.
- "Cutting Rates" means reducing interest rates, again, usually by 0.25% at a time.

Along the same lines,
"Dovish Statements" means language that doesn't really indicate a rate hike.
"Hawkish Statements" means language that more strongly points to a rate hike.

So, you could say that today, they raised rates 0.25%, and made hawkish statements about not two, but three more rate increases in 2017. Should this happen, it would constitute a rate hike.

Here is an excellent video on the topic:
More...
Thanks for the very clear answer!
 
Think of interest rates ....as the earth's crust or surface or foundation;
Everything kind of reverberates off of that o_O;) ...on a macro scale.

(for a more detailed, complex answer....research it yourself)
 
As far as I understand, the relationship to stocks has to do with how the interest rate affects the value of the dollar.

Higher interest rates mean a stronger dollar, i.e. a dollar is worth more.
Since a dollar is worth more, you need less dollars to refer to the same underlying value, which is why stocks can get devalued numerically by a rate hike.

That being said, rate hikes imply that the economy is doing well, which should be good for stocks.
Companies that profit from charging interest, like financials, benefit.

Also, when interest rates are low, equities are useful compared to other investing vehicles, but when interest rates start increasing, other investment vehicle start becoming more valuable, so everybody rotates out of equities into these other instruments.
 
My 2 cents.

Normally an interest rate hike is initially negative for stocks... eventually a hike means higher financing costs for companies, which on that basis means lower earnings. Also, it would mean the other options investors have become more interesting, those options meaning variable rate instruments. Higher interest rates also means lower bond prices/higher bond yields. That effect has a stronger relationship, especially in short term bonds. Mind you, the entire yield curve can change. Front yields might go up, but long term yields might drop.
The fact that bonds become more cheap, means investors suddenly find that option also more interesting and jump from stocks to bonds, also putting more pressure on stocks.

In the last few years with interest rates being extremely low globally... and particularly in US and Europe... I could argue that a slow rise in rates might not be a bad thing for stocks, since it means economic recovery is finally progressing. Although we're at (all-time) highs, recovery should mean higher margins and earnings...

@CyJackX puts it fairly correct IMO. At the moment I see a slow rise in rates as a good thing on the road to normal conditions...
 
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