are one of the most important factors determining the behaviour
of the markets. There is generally an inverse relationship between
the market and rates - for example, when interest rates are high,
money tends to flow OUT of the stock market, deflating stock prices,
because a better return can be had from interest-bearing instruments.
Similarly, low interest rates encourage money to flow INTO the markets,
inflating prices, because the returns on stocks (dividends and capital
appreciation) seem better than the interest that will be received
outside the market. Rising interest rates also cause retail sales
to fall (it becomes more expensive to borrow for consumer goods,
as well as to support a margin account). Falling sales eventually
lead to reduced corporate profits, which cause the stock market
to fall, and ultimately higher unemployment. When day trading, traders
may use interest rate announcements as a sign to stay out of the
market until 'the dust settles'.
A further consideration
is corporate bonds. Riskier than Treasury Bonds, companies borrow
money with these instruments by offering above average interest
payments on them. The higher interest rates generally, the higher
corporate bond rates must become in order to still be competitive.
And paying those interest payments (the 'yield') can become crippling
for companies in times of high interest rates. Government bodies
have control of the 'discount rate' (or 'base rate'), and modify
it periodically in order to try and control the economy. The discount
rate is the rate at which a country's central bank will lend money
to retail banks. They in turn 'mark up' this rate before passing
it on to their customers.
In recessions, governments
tend to ease discount rates in order to encourage borrowing and
spending. If inflation starts to get out of control, the discount
rate may be raised in order to discourage spending and put the lid
back on rising prices. Related topic - T-Bills. These are short
term bonds issued by the Government to raise cash.They last only
up to 26 weeks, and usually return a good rate of interest relative
to interest rates generally.