Thursday, December 17, 2009

Higher Rates Maybe Bullish For Stocks

The Prime Interest Rate: the interest rate charged by banks to their most creditworthy customers (usually the most prominent and stable business customers).
In a “60 Minutes” interview Sunday, President Barack Obama’s message to the “fat-cat bankers”,who were summoned to the White House Monday and told to open the lending spigot. Obama chastised bankers for their irresponsible actions that got us into this mess. >>Read More

*click chart to expand image

As you can see in this chart, a higher Prime rate is bullish for stocks, at least for the last decade it has been. Interest rates affect but don't necessarily determine the moves in equities. The interest rate, commonly bandied about by the media, has a wide and varied impact upon the economy. When it is raised, the general effect is to lessen the amount of money in circulation, which works to keep inflation low. It also makes borrowing money more expensive, which affects how consumers and businesses spend their money; this increases expenses for companies, lowering earnings somewhat for those with debt to pay. Finally, it tends to make the stock market a slightly less attractive place to investment.

Keep in mind, however, that these factors and results are all interrelated. Granted what's described above are very broad interactions, which can play out in a number of ways. Interest rates are not the only determinant of stock prices and there are many considerations that go into stock prices and the general trend of the market - an increased interest rate is only one of them. Therefore, one can never say with confidence that an interest rate hike by the Fed will have an overall negative effect on stock prices.
The Fed's decision not to raise rates this week, doesn't mean their not thinking about it. Most likely, there was discussion of an exit strategy at the meeting, as was the case in November, low inflation expectations give the Fed a chance to hold off on a rate hike as long as possible. The timing of a rate hike will also depend on how fragile the psychology in the financial market is. The last thing the the Fed wants is to precipitate another financial crisis by implementing the exit strategy too soon. My view is and continues to be, that you won't see interest rates move higher until there's job growth!

On another note the Senate Banking Committee voted 16-7 to confirm Fed Chairman Bernanke for a second term.

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