US Interest Rate Rise

bowlhead99 wrote: »

As a general rule if interest rates rise it is negative for the stock markets of that country for several reasons:

- it is harder for businesses to borrow money to help them grow or maintain the business and expand their profits

- consumers in that country have less money to spend because their mortgage costs are higher and loans and credit cards are more expensive and saving is relatively more attractive than spending. Lower spending on goods and services equals lower revenue for the companies on the stock market.

Those things slow the economy and can reduce growth and employment. Then:

- when an investor is looking at how much he is willing to pay for a company, and the base interest rate is pretty high, it's relatively less attractive to buy shares in a company or existing bonds issued by a company for the same price that was being asked the day before. That's because the excess of your potential returns from the investment over what you could get from a simple cash deposit or new low risk bond, is not so high as it was earlier.

So for all those reasons, and some other more subtle ones (including effect on exchange rates and potential exports by US companies etc), generally an increased interest rate is a negative event for markets, not a positive one.

Of course, in some circumstances like now when the rates have been really really low for ages (to avoid hurting the economy), an uptick in the interest rate is not quite so negative as people might have expected from the above theoretical reasons... because it is a sign that if the central bank are willing to put the rates up and risk slowing the economy, they must think the economy is generally doing pretty well to be able to 'handle' that rate rise, so that's generally a positive vibe.

When the markets think there is a potential for something to happen at a forthcoming Fed announcement (like in interest rate will increase, decrease, or stay the same) the market prices will reflect the best guess of what would happen.

So if it's believed likely (but not 100% certain) that rates will go up next week, the market will move a lot closer to where it would end up in the case of the rates announcement being 'rate rise' than where it would end up if the announcement would be 'rates on hold' or 'rates going down'. Most of the expected movement is 'priced in'. Then when the actual announcement is made, and it's what everyone was expecting anyway, the market won't move too much, it will just move the little extra bit to its final position, because it had already moved nearly all the way.

So, if you and the media and the investors around the world nearly all think that there is going to be a rate rise next week, which would have caused a small market drop, then the share prices will already move close to where investors think they will end up - for example on 10 March the US indexes are already a percent or so below where they ended on 1 March. So may not be much more of a move.

The other aspect for you as a UK investor is that the pound to dollar exchange rate is affected by difference in interest rates between the countries and expectations for the future interest rates movements. If the dollar interest rate is higher than the pound interest rate, investors around the world would find it relatively more attractive to buy US dollars and hold them with US banks, or to buy US government bonds and so on, than to hold pounds. So they will sell pounds and buy dollars, or borrow pounds to invest in dollars. That change in the supply and demand for dollars will make dollars more expensive to buy, in terms of how many pounds you have to pay for a dollar.

So as a US rate rise gradually becomes more likely, or closer to happening, and then actually happens, dollars start to cost more pounds (be worth more pounds). So your Microsoft share which sells on the stock market for $65 is worth more pounds to a UK investor with a strong dollar than if $65 was worth fewer pounds. Since a US rate rise started to sound more likely over the last couple of weeks (together with other negative effects on the pound like Brexit getting closer), the dollar has gone from being worth 80p two weeks ago to 82p today. If the interest rate rise does indeed go ahead it will potentially make the dollar worth even more pence.

So, the US market could fall a little bit (because most but not all the interest rate rise is priced into the US stock market level at the moment) but dollars could be worth more pounds (because most but not all of the exchange rate change is priced into the currency market level at the moment) - and then the net effect of the change in the value of your US shares, when translated to pounds, would be pretty much nothing.

Taken at face value though, your question 'would a US rate rise push the US stock market to an all time high' the answer is probably 'no, you have got that backwards'. Because the effect of an interest rate rise is (usually) to dampen down the profitability and attractiveness of the companies in the market, not increase them - as per the first few paragraphs above.