Interest Rates and Stock Market

All over the world, central banks control interest rates. The Reserve Bank of India controls the repo rate in India. In the USA, the fed interest rate is controlled by Federal Reserve Board. Many times, when the USA decides to increase federal rates, the stock market in India faces Bloodbath, and the market falls by thousands of points.

What is the interest rate of the Central Bank?

The interest rate that a country's central bank charges its domestic banks to borrow money is known as a "bank rate." Rates charged by central banks are set to balance the economy. The bank rate, also referred to as the discount rate, is set in the United States by the Board of Governors of the Federal Reserve System. In India, it is done by the Reserve Bank of India, by the name of repo rates.

Numerous central banks have altered their bank rates in response to the global financial crisis to boost and stabilize the economy.

To maintain liquidity and satisfy reserve requirements, banks ask the central bank for loans. According to the needs of the bank and its financial situation, the Federal Reserve issues three different types of credit:-

● Primary Credit:- It is given to financially sound institutions. It ensures liquidity in the bank.

● Secondary Credit:- It is a short-term credit which has a higher rate of interest and has a period equivalent to overnight.

● Seasonal Credit:- Used for an institution with demonstrated liquidity pressures. The overnight rate is the interest rate that banks charge one another to borrow money, as opposed to the bank rate.

How does it affect Stock Market?

In simple terms:-

● If the interest rate goes up, the stock market will fall sharply.

● If the interest rate goes down, the stock market will increase wildly.

In terms of immediate effects:-

● Companies with high debt loads combined with higher interest rates experienced lower earnings per share (EPS).

● Stocks would be unattractive to investors and experience price erosion.

● Over time, higher interest rates will affect real estate, heavy engineering, and transportation.

It may once more discourage investors from investing in these industries, particularly if they are saddled with higher interest rates.

It is well known that interest rates have a significant influence on stock markets. There is a negative correlation between the two.The stock market's activity starts to decline as interest rates rise. Capital-intensive industries suffer from higher interest rates, but they stand to benefit the most when they decline.Therefore, it is advisable to stay away from investments in the real estate and auto industries when interest rates are on the rise. Additionally, it has been noted that the IT and pharmaceutical industries are less burdened or impacted by higher interest rates.

The bloodbath

After the increase in fed rates/repo rates, the market falls by a lot of points which leads to investors losing lakhs of crores of rupees as they start panic selling due to the same.

For example, on 15th June 2022, USA Federal Reserve Board increases the Fed rates by 0.75%. The news for the same was there as a rumour since 9th June. The market fell from 55,320 points on 9th June to 51,495 points on 16th June. On 16th June itself, the market fell by 1046 points as soon as hike rates were announced. This caused a blood bath in the market making investors lose money in lakhs of crores.

Conclusion

Interest rates are not directly related to the stock market but they influence our market a lot. Whenever Fed Rates are raised, the market is meant to fall. Whenever Fed Rates are reduced, the market rises. Fed rates affect the market heavily and many investors buy stocks within one to two days of the rate hike.