BUSINESS

Is Fed Easing Actually Good For The Market?

03/28/2008 02:46 am ET | Updated May 25, 2011

Is it really as simple as "When the Federal Reserve cuts rates, it's great for the market" or "When the Fed raises rates, it's bad for the stock market"?

Michael Panzer of Financial Armageddon recently asked this question, as well as provided an excellent graph detailing stock market returns and Federal Funds rate at his post "Is Aggressive Fed Easing Really Bullish for Stocks?"

This is a concept I've been at odds with the financial media for quite some time, but I felt alone in my view.

Traditional thinking goes like this:

"When the Fed raises rates, it chokes off money supply through higher interest rates and decreases capital expansion, so it's bad for the market. However, when the Fed lowers rates, it's great for the market for the opposite reason. With lower cost of carry rates and lower interest payments, companies can take on more loans and expand their business, as well as the consumer can purchase more items (including bigger purchases like houses and cars) on credit or loans (or mortgages)."

That's absolutely true, but what does it mean when the Fed raises or lowers rates?

Typically, the Federal Reserve raises interest rates to prevent rampant inflation from runaway expansions caused by 'easy money.' If the Fed kept rates at 1%, then so many businesses would be expanding and consumers would be spending that inflation (through higher demand) will causes everyday prices to skyrocket as well.

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