Why does the stock market experience major gains when the Fed announces that they are holding rates steady?

Question

I can see some of the positive implications for the long-term economy. But at the same time, by holding the rates steady even though we don't have inflation completely under wraps, isn't the Fed in a sense almost implying that the economy currently isn't too stable, and perhaps even a little bit fragile? Wouldn't any stock market investors take it to mean that the Fed doesn't want to raise rates any more to keep inflation in better check because we are already at risk of going into a recession and raising rates, even slightly, will increase that risk even more?

But we can't borrow money to perform business enhancements for less money, when rates are held steady. It means that we can borrow money to perform business enhancements for the same amount of money as before.

Answer 1

It is a matter of risk vs. return and expectations. The expectation is that the US will start showing inflation an so that interest rates will go up. If interest rates are going to go up, where do you put your money? Not in the stock exchange, because it will be too difficult to take it out later without a loss, but you don't put it in fixed income instruments because you think interest rates will be better soon. So you wait until the Fed decision is made, usually holding the money in a deposit. We are talking investment funds, 401K's, the works, all sitting in a holding pattern for the FED. Suddenly, the FED comes out and says that interest rates will not go up, so all the money sitting in a holding pattern goes to the stock exchange, pushing prices up.
If the FED had declared an increase in the rate, you would have seen a re-balancing of portfolios, from equity investments (which are riskier) to fixed income investments, because the risk/return relation has changed (for example, why invest in a risky equity asset for an expected 12% annual return on average when you can invest in risk free bonds for 7% instead of the old 6%.)

Answer 2

The Fed has been increasing interest rates over the past several months. Markets have been expecting interest rates to continue rising, so the Fed announcement was a surprise.

Now, how did this surprise work its way into stock prices?

The price of a stock is the present value of all future capital gains and dividends from owning that stock. Algebraically, we can say that

P = D0 + D1/(1+R1) + D2/(1+R2)+ D3/(1+R3) ........

where the Ds denote dividends in future periods and R represents interest rates in future periods.

The Fed's announcement led markets to lower their forecasts for the future Rs. A lower R means a higher P -- that is, higher stock prices.

Voila!

Answer 3

Anything to do with the stock market is about people's expectations. Stock market's reaction therefore depends on the current trend. If the economy is suffering from high inflation, and Fed announces that the rates are not changing, then that is good news, and hence people react positively.
The rates alone are not explanatory enough. You should consider what they said about future expectations as well.

Answer 4

Just excuse my english, I'm not from the US.

First of all EXPECTATIONS....

The fed anounces steady rates because they expect less risk of high inflation levels even though they say the risk might still be there ( I don't think so but that's another story......)

So the expected price of money (expected interest rate) is now lower (at least they won't give a hike on interes rate)

As an investor I expect to borrow cheaper money now or in the future to buy stocks

As an investor who has bonds.... The expected interest rate goes down, price of bonds go up, I sell them and invest them on stock market (my oportunity cost of not investing in bonds is less for the next period of time)

As a corporation listed in the stock market I can borrow money cheaper for aditional proyects that can make grow my corporation and the value of it

As an entrepreneur, my proyects can have more value with lower rates

Next VALUE OF A STOCK
the value of a firm is the present value of all the flows a company will generate on its life plus a residual value. To get the present value you have to divide the flows with the interest rate.... so with lower interest rate in the near future the value goes..... UP



Another...HIGHER RISK OF RECESSION WITH HIGHER RATES
Yes you can think that the Fed is acting because they have data that might sugest a recession is coming, so they will lower the i rate.... but if the risk is already there..... at least now with a neutral policy they are starting to act but not so fast

And at last.... the Fed is the Fed but they don't really have a magic crystal ball to see the exact future so maybe.........

If the economy is not so fragile as you say, and there's still inflationary risk out there...... you don't want to borrow money cheaper and invest it? I'm sure you do...

I'm sure there's a lot of other explanations but those are the one's that came to my mind this time

Answer 5

The slowdown isn't undesirable information, on account that earnings are nonetheless solid/semi growing and inflation is subsiding. The concensus is that on account that inflation is falling, so the fee of doing business enterprise will be more less expensive meaning extra boom a minimum of briefly and clientele will commence spend extra in different elements.

Answer 6

it means the economy is not inflated..
the only time rates are raised and lowered is to keep inflation in check..

at this time the fed thinks things are okay..so no need to increase the rate (which affects lending etc..)

There's more to it then this..but that's a very basic overview..

Answer 7

It means that you can borrow money to perform business enhancements for less money.