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Interest rate cut approaching: is it good for the stock market? βΉοΈ
There's a reason investors' eyes are now on the Fed π
Recent economic data has come in below expectations, signaling weakening inflation, which immediately impacted estimates for an interest rate cut. π¦
In fact, the market is now pricing in a rate cut as early as September, with at least 2 cuts already in 2025 βοΈ
And as interest rates decline on the horizon, smiles on Wall Street widen. π
But why is an interest rate cut considered good news for the stock market β
Here's the explanation: π‘
When the price of money falls, the stock market may awaken β°
Interest is essentially the price of money. π΅
When it's high, it's more worthwhile to 'sit on cash', meaning, to invest in conservative instruments like money market funds. πͺ
But when interest rates fall? π
Money becomes 'lazy' if it just sits in an account, so people start looking for returns,
And where do they go? πΊ
To stocks. π―
Money market funds, with $7.2 trillion parked on the sidelines. π²π²π²
As of today, money market funds in the US manage a colossal sum of about $7.2 trillion (!). π²
The reason?
They offered investors an attractive alternative during a period of high interest rates: high liquidity, decent returns, and low risk. π₯
But with the start of interest rate cuts, the returns on these funds will be slashed, and they will become less appealing. π₯
Suddenly, stocks of growth companies with high profit potential look much more interesting π
There are additional reasons why the stock market benefits from a rate cut:
Cheaper financing for companies: π΅ Companies raise debt at lower interest rates, which contributes to profitability and sometimes to expansion investments. πͺ§
Investor pressure to move to stocks: π€ΎββοΈ When bonds are no longer appealing and returns on conservative instruments erode, money seeks an alternative. And this alternative, usually, is the stock market. π±
For now, it looks like a question of not 'if' but 'when' π
An interest rate cut is not the sole reason for a market rally, but it can certainly be the spark that ignites a wave of incoming money, especially when it has been on the sidelines for a relatively long period. π