How Do Fed Rate Cuts Affect Stocks?
Rate cuts are not automatically good for stocks. What matters is why the Federal Reserve is cutting. Here is what happened after past first cuts, with and without a recession, and how cuts reach share prices.
GlossaryGlossary
What Is the Fed Funds Rate? Definition and Example
What the federal funds rate is, how the Federal Reserve sets it, and how changes in it reach your stocks, bonds and cash.
Key takeaways
- The federal funds rate is the interest rate banks charge each other to borrow overnight. The Federal Reserve sets a target range for it to steer the economy.
- The Fed’s Federal Open Market Committee (FOMC) has eight regularly scheduled meetings a year and announces decisions at 2 p.m. Eastern Time.
- Raising the rate tightens financial conditions; cutting it loosens them. The effect reaches mortgages, bond yields, cash yields and stock valuations.
- In 2022, a year of fast rate rises, long-term Treasuries (TLT) fell 31.2% and the S&P 500 18.2%, in Exent’s data.
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What is the fed funds rate?
The fed funds rate is the price of overnight money between banks. The Federal Reserve does not set each loan; it sets a target range and uses its tools to keep the actual rate inside it. It is the anchor for short-term rates across the economy.
How does the fed funds rate affect markets?
- Cash: money market and savings yields follow it closely.
- Bonds: Treasury yields move with expected policy; long bonds lose value when yields rise (see bond duration).
- Stocks: higher rates raise the discount rate on future profits, which weighs most on long-duration growth stocks.
- The economy: borrowing costs for homes and businesses change, with a lag.
Worked example: 2022
The Fed raised rates quickly in 2022 to fight inflation. Here is how different assets took it:
| 2022 return (Exent data) | Return |
|---|---|
| T-bills (BIL) | +1.4% |
| S&P 500 (SPY) | −18.2% |
| 7–10 year Treasuries (IEF) | −15.2% |
| 20+ year Treasuries (TLT) | −31.2% |
Short-term cash gained as its yield rose with the Fed; the longest bonds lost the most.
Why it matters for a self‑directed investor
Rate decisions change the return on cash and the value of long bonds and growth stocks, so they affect most portfolios at once. See how rate-sensitive is your portfolio and Fed rate cuts and stocks.
Common mistakes
- Reacting to the decision itself. Markets usually price expected moves weeks in advance.
- Assuming rate cuts are always good for stocks. Cuts in response to a recession often came with falling markets.
- Treating bonds as safe from rate rises, as 2022 showed.
Frequently asked questions
The Federal Open Market Committee (FOMC) of the Federal Reserve sets a target range. It has eight regularly scheduled meetings a year.
Higher rates make borrowing costlier and raise the rate used to value future profits, which tends to weigh on stock prices, especially growth stocks. Cuts work the other way, though the reason for the cut matters.
Yes. Savings and money market yields tend to follow the fed funds rate up and down.
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Educational content, not investment advice. Examples are illustrative; past performance does not guarantee future results.