Market Interest Rates
“Fed Rate Cut: It’s Not What You Think” by Rob Isbtts. Forbes.
1.
This article is discussing the U.S. Federal Reserve cutting of the federal rate. It is relevant because interest rates affect the performance of the entire economy, which is why they are often used as a monitory policy to control factors such as inflation, unemployment, and slow economic growth. According to OECD (2020), the global economy is very reactive to various pandemics in the world, and most recently, the Coronavirus is weakening the economy. Hence, it is slowing the economic growth of many countries, including the U.S. Therefore, from the article, one can understand why the U.S. Federal Reserve is cutting the interest rates, which is their effort to increase economic activity. Also, the article allows one to know that the current state where interest rates are headed to the negative could be harmful to the economy because it may cause inflation leading to a financial crisis.
Correspondingly, interest rates affect various investments inclusive of bonds and stocks; therefore, this article explains what will happen to investments to prepare investors or help them hedge their funds against certain risks. At the beginning of the month, the news was continually covering the effects of lowered interest rates on stocks and bond prices. It was newsworthy because the investors did not react as it was expected, it had been predicted that investors would move to riskier investments such as stocks when the fed rate was cut. Instead, investors saw it as a sign of a financial crisis; thus they moved to low yielding bonds for safety (Barro, 2020). For this reason, the article is essential to investors as it shows them that while some investments may be affected positively by interest rates, cut investor sentiments are also very critical to the performance of investments.
2.
In explaining the effects of interest rates on investments, the article gives a clear understanding of the relationship between the chapter concepts. For instance, it reveals that wall street is happily anticipating the federal rate cut as it will increase consumer spending hence growing corporate earnings and, in relation, rising stock prices. From this, we understand that a fall in interest rates causes an increase in stock prices because both individuals and businesses will enjoy borrowing low interest rate loans. Hence they will have more money to spend, and consequently, all this spending will impact listed companies positively. As a result, investors will want to buy stocks in anticipation of an increase in stock prices and dividends.
On the other hand, fixed-rate investments are impacted negatively by a decrease in interest rates because it decreases the yield on investment. Case in point, according to the article, a reduction of interest rates causes a rise in bond prices as the government will want to buy back its debt and later refinance using low interest bonds, which are less expensive. Similarly, the yield on certificate of deposit and money market securities will decrease because banks will have to lend at a lower rate, which will reduce their interest margins. Therefore, to maintain their interest margin, they will drop the interest paid to savers.
3.
Consequently, the relationship between these concepts will act as a guide for investors. For example, individual investors may prefer to invest in riskier securities such as stocks as they will have better yields compared to fixed-rate investments. On the other hand, banks will reduce lending to individuals as the interest income will be too low, so instead, they will increase the funds allocated to stocks and also, they will increase their lending to the government as a safety net. Correspondingly, non-financial institutions will also change their preferences for raising capital, where they may reduce the sale of stocks and increasing corporate bonds and bank loans as they will appear to be cheaper due to the low interest rates.