Interest Rates Remain Steady, Offering Relief to Nervous Stock Market
After a bear run for most of 2022, the stock markets have stabilized, and analysts believe the worst is over. The renewed optimism has a lot to do with the fact that interest rates are now steady, and there is hope that if Central Banks drop their hawkish stance, the markets could return to a new fully-fledged bull run.
While many factors move stock prices, interest rates are the most important. This leads to the question, what is the relationship between interest rates and stock markets? From an analysis of interest rates v stock market chart, you will notice an inverse relationship between the two. Whenever interest rates go up, the markets drop, and vice versa.
Why the inverse relationship?
To understand why stock markets are currently stabilizing, it is essential to know the factors that drive the inverse relationship between stock prices and interest rates. Here are some of the most important ones.
Low-interest rates and the markets
When interest rates drop, there is an incentive to borrow. Companies can borrow more, which gives them the liquidity to expand their operations. They can also buy back their own shares, which drives up share prices.
At the same time, low-interest rates incentivize consumers to borrow more. The result is that they have a higher purchasing power, which translates to more profits for corporations. Individuals who make up the bulk of retail money in the stock market are incentivized to take risks, which adds to the rising demand for stocks.
Everything is geared towards driving up the market in a low-interest rate environment.
Rising interest rates and the markets
When interest rates go up, it has the opposite effect to what you get in a low-interest rates environment. For instance, borrowing becomes expensive for corporations in a rising interest rate environment. This means expected profitability from expansion drops, which cuts the incentive for money to flow into stock markets.
Instead, money tends to flow more into fixed-income securities such as bonds, which offer attractive interest rates when the base rate is high. Consumer spending tends to drop, too, as consumers lose the incentive to spend on non-essentials or make risky investments.
Why relief for nervous markets?
Markets love it better when interest rates are low or declining. Currently, the interest rate is relatively high, given that they were almost zero a few years ago. That’s why the market has a sense of relief because as long as there are no further aggressive rate hikes, we have now what was normal before the post-2008 period of zero interest rates.
At the same time, there is a relief that while interest rates may have gone higher, things could improve on the production side of things and help offset the impact. For instance, at the moment, supply chains are close to getting back to complete normalcy after they collapsed in 2020. Emerging technologies like AI are also poised to make production much cheaper and more efficient.
On the consumer side, markets are betting that the successive interest rate hikes of 2022 may impact consumers less. That’s because they don’t hurt much, considering that rates were near zero or below zero in some jurisdictions.
In essence, stabilizing interest rates at current levels for the stock markets means a return to normal after a prolonged recovery from the 2008 financial crisis.
Conclusion
Despite a series of rate hikes in 2022, markets are calm in 2023. That’s because, coming from zero or negative in some countries, what is being experienced is simply a return to a typical interest rates environment. As such, if the Central Banks drop the hawkish stand in 2023, the odds are that markets could take that as a plus, leading to renewed optimism in the stock markets.
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