How Rate Hikes Affect Markets
Stocks: Higher rates increase borrowing costs and raise the discount rate applied to future earnings, reducing their present value. Growth stocks and highly leveraged companies are most affected.
Bonds: New bonds offer higher coupons; existing lower-coupon bonds fall in price. Long-duration bonds suffer the most (higher interest rate sensitivity).
Currency: Rate hikes attract foreign capital seeking higher yields, strengthening the local currency. The DXY surged to a 20-year high in 2022 as the Fed hiked aggressively.
How Rate Cuts Affect Markets
Stocks: Cheaper borrowing and a lower discount rate make future earnings more valuable; growth and tech stocks typically rally. When the Fed cut to zero in 2020, tech stocks soared.
Bonds: New issuance carries lower coupons; existing high-coupon bonds rise in price. Bond investors benefit.
Emerging markets: Low US rates push investors to seek higher yields abroad, driving capital into emerging markets.
Fed Rate Decisions and Global Markets
The Federal Reserve's Federal Open Market Committee (FOMC) meets eight times per year to set the federal funds rate. Markets closely watch FOMC statements and the "dot plot" — a chart showing where each Fed member expects rates to be in future years.
Rate decisions ripple globally: a Fed hike strengthens the dollar, pressures emerging market currencies, and typically tightens global financial conditions.