How interest rates affect capital markets？

It usually takes at least a year for an increase or decrease in interest rates to have a real effect on the entire real economy, but the capital market tends to react much faster to interest rate changes (or, more precisely, news of interest rate changes).

Why is the federal funds rate, the rate at which banks lend money, so important? Because the base interest rate (preferential loan rate) charged by commercial banks to high-credit customers is mainly determined based on the level of the federal funds rate. Interest rates on other forms of mortgage lending such as mortgage rates, credit card APRs and a range of other consumer and business loan rates are based on the base rate.

When the market economy overheats and the supply of funds in the market exceeds demand, prices will rise on a large scale, resulting in inflation. The federal funds rate is how the Federal Reserve attempts to control inflation. In principle, the Federal Reserve raises the federal funds rate, increases borrowing costs in the market, and reduces the scale of social investment, thus shrinking the supply of funds in the market.

On the contrary, when the Federal Reserve lowers the federal funds rate, it will reduce the cost of borrowing in the market, encourage consumption, expand the scale of social investment, and thereby increase the money supply. The operating principles of monetary policy of central banks in various countries are the same.

When the economy slows, the Fed lowers the federal funds rate to stimulate the economy. Lowering interest rates will have the opposite effect on the market than raising interest rates.

Investors and economists believe that interest rate cuts are a catalyst for economic growth - helping individuals and businesses reduce loan costs, thereby stimulating economic growth and increasing corporate profits and personal income levels. Lower interest rates stimulate consumption, and people buy new homes or send their children to private schools; businesses have lower costs of capital to operate, acquire, and expand, thereby increasing their future profit potential, which in turn leading to higher stock prices.

Benefits from lower federal funds rates include utilities and real estate investment trusts. In addition, large companies with stable cash flows and a solid balance sheet structure will also benefit from cheap debt financing.

Interest rates are closely related to the stock market. When interest rates rise, a business will cut back on its spending, often in the form of higher debt payments or less revenue, and its future cash flows will inevitably declin.

Because a key way to measure the value of a company is to discount the sum of the company's future cash flows into the present value. The present value divided by the total number of shares issued is the company's stock price.

With expectations of a company's growth and future cash flow decreasing, investors believe there is little room for stock price appreciation and will reduce the number of shares they hold. In addition, when the Federal Reserve raises the federal funds rate, the "risk-free" rate of return in the market will increase, and the total rate of return required to invest in stocks will also increase accordingly.

Therefore, if the risk premium decreases and the potential return remains the same or becomes lower, investors may feel that the stock is too risky and invest their money elsewhere. If enough companies' share prices fall, the entire stock market or a major stock index (such as the Dow Jones Industrial Average or S&P 500) will fall.

However, some industries will benefit from interest rate increases, among which the financial industry will benefit the most. Banks, brokerages, mortgage companies and insurance companies often see their earnings rise as interest rates rise because they can charge more for their loans, thereby increasing their own revenue.