The Dow is down by about 200 points right now. The radio and the SF Chronicle said that stocks are down so far because the stronger-than-expected rise in the consumer price index might mean that interest rates will keep going up.
This is probably a dumb question (I know almost nothing about economics or the stock market), but why does the market react so strongly to any hint that interest rates might go up?
Higher interest rates mean higher debt expenses for companies which translate to lower earnings.
The stock market is speculative. Investors are interested in what will happen to the company in the future. If earning projections take a fall then the value of the company also takes a hit.
Higher interest rates also make bonds a relatively more attractive investment than stocks, which would tend to make people sell their stocks, buy bonds, and drive the stock market down.
High interest rates reduce investment by companies, individuals and even the government. This has the effect of slowing down the economy. Lower investment mean fewer jobs fewer growth prospects for the economy.
This is also why tax cuts can hurt the economy. As the government deficit increases through lower tax revenue, the government has to borrow money in the form of T-bonds. Thus the government ends up competing with private industry for dollars by increasing interest rates. This is known as the “crowding out” effect of tax cutting.
Which has been basically discredited. Tax cuts have been empirically shown to be net stimulative, at least at our current levels of taxation.
What got me when I read about this on CNN today was that they attributed the drop to “consumers” being worried about the CPI. Like “Mom and Pop” investors make thier investment decisions based upon the CPI and that they all put down there coffees today and called there brokers as soon as they heard the news! The actual consumers they were talking about are a small number of big investment firms that stand to lose or make billions based upon such percieved changes. I think Mom and Pop just thought, well damn we’re getting a real screwing on gas prices this last month no wonder the CPI went up.
Cite please. Tax cuts can stimulate the economy by raising consumption…people spend more money. Additionally, tax cuts actually yield HIGHER government spending since people perceive them as a discount on government services and demand more government, which goes against the “starve the beast” idea. This also can stimulate the economy. But investment must be sacrificed (no such thing as a free lunch), and investment is what drives future growth.
Since stock value is actually a measure of perceived future earnings (cash flows, actually), stock prices naturally fall when interest rates are higher.