When interest rates rise the cost of borrowing money increases which makes people more reluctant to borrowing money and developing new projects. In addition, when interest rates rise people make more return on their money when they put it in the bank because of the higher interest rate yield. Those two reasons together affect stock prices, in the following paragraphs i will explain the exact process that leads to this price change after the interest rate moves.
People become discouraged to put their money in stocks
This combination results in letting people pull money out of the stock market in order to put it in banks. After all, if the bank is going to guarantee a 6 percent return on investment whereas the stock market yield is unknown then why should the investor put his money in stocks? Now what if the bank gives a 12% interest on deposited money, doesn’t this encourage investors to pull money out of stocks to put them in banks?
The economy slows down
When the interest rate goes up, financing new projects becomes more expensive and so people become discouraged to make new projects. This leads to a downturn in the economy due to the slow down in business activity, and since the whole economy is connected together, existing companies start to make less profits because of the slowdown.
This results in letting investors sell the companies fearing that they may make less profits in the coming quarter because of the interest rate changes. Now you might be asking yourself a question “If the effect of the interest rate change wasn’t felt yet, then why do stock prices move?”
The answer to this question is simple, stock prices move according to future expectations not to current results. For example, If Wall Mart announced that it will double its profit next year, its shares will go up even though the next year didn’t come yet.
