Quick answer
Interest rates change how attractive stocks are compared with other ways of holding money, and how much investors will pay today for profits expected later. The Federal Reserve notes that lower rates "can make holding equities more attractive" [1]; higher rates tend to work the other way.
Key points
- The federal funds rate is the rate banks pay to borrow reserve balances overnight; the Fed's FOMC sets a target range for it.
- Changes in that rate spread quickly to short-term loan rates and, through expectations, to longer-term rates.
- A stock's value rests on profits expected in the future, and higher rates shrink what those future dollars are worth today.
- Profits expected far in the future are hit harder by a rate change than profits expected soon.
- Rates are one influence among many; the link to stock prices is not mechanical or immediate.
#What is the federal funds rate?
The Federal Reserve is the central bank of the United States. Its main policy tool is the federal funds rate, which the Fed defines as "the interest rate that banks pay to borrow reserve balances overnight" [1]. The Fed does not set one exact number; it announces a target range and the effective date of any change falls on the day after the meeting ends [2].
The decision is made by the Federal Open Market Committee (FOMC). It has twelve voting members — the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York and four of the other eleven Reserve Bank presidents — and it holds eight regularly scheduled meetings a year [3]. Under the Federal Reserve Act, the Fed's goals are maximum employment, stable prices and moderate long-term interest rates [1].
#How does a Fed decision reach the rest of the economy?
The Fed says changes in the federal funds rate are rapidly reflected in the rates banks and other lenders charge on short-term loans, while longer-term rates depend on what markets expect policy to be in the future [1]. Lower rates reduce borrowing costs for homes, cars and business equipment; higher rates raise them.
From the FOMC to stock prices
The Fed itself stresses that "the linkages from monetary policy to both inflation and employment are not direct or immediate" [4]. The same caution applies to stocks: a rate change is one input, not a switch.
#Why do lower rates tend to support stock prices?
The Federal Reserve gives the short answer: "Changes in interest rates tend to affect stock prices by changing the relative attractiveness of equity as an investment and as a way of holding wealth" [1]. It adds that "Lower interest rates can make holding equities more attractive, which raises stock prices and adds to wealth" [1].
Think of it as a comparison. If a savings account or a Treasury bill pays more, the extra return an investor demands for taking stock-market risk has to come from somewhere — usually a lower purchase price. When safer options pay less, stocks look relatively better, and buyers may accept a higher price. The same logic explains why, according to the SEC, "When market interest rates rise, prices of fixed-rate bonds fall" [5]. Our guide to bond prices and interest rates shows the bond version step by step.
#What does discounting have to do with share prices?
A share is a claim on profits a company may earn in the future. Money in the future is worth less than money today, because today's money could be earning interest. The St. Louis Fed calls this the time value of money and defines present value as "The current value of a future sum of money, given a specified rate of return" [6]. The formula is PV = FV ÷ (1 + r)^n, where FV is the future amount, r the interest rate and n the number of years [6].
Turning a future amount into a present value is called discounting, and the rate used is the discount rate. When interest rates rise, the discount rate investors use usually rises too, so every future dollar is worth less today — even if nothing about the business has changed.
Worked example
Same $1,000, different interest rates
You are promised $1,000 in 10 years. What is it worth today at three different rates? Formula: PV = 1,000 ÷ (1 + r)^10.
- At 3% (1,000 ÷ 1.03^10)
- $744.09
- At 5% (1,000 ÷ 1.05^10)
- $613.91
- At 7% (1,000 ÷ 1.07^10)
- $508.35
Moving from 3% to 7% cuts today's value of the same promise by about a third. Nothing about the $1,000 changed — only the rate used to discount it.
Hypothetical figures calculated in Python. Real stock valuation uses many uncertain future cash flows, not one promised amount.
#Why do some stocks react more than others?
Timing matters. Profits expected soon are barely affected by a change in the discount rate. Profits expected 20 years from now are affected a lot, because the rate is applied again and again. Companies whose value depends mostly on profits far in the future — often described as growth companies — therefore tend to be more sensitive to rate changes than companies earning steady profits today. See growth vs value stocks for how the two styles differ.
| Received in | Worth today at 4% | Worth today at 6% | Change from a 2-point rate rise |
|---|---|---|---|
| 2 years | $92.46 | $89.00 | −3.7% |
| 10 years | $67.56 | $55.84 | −17.3% |
| 20 years | $45.64 | $31.18 | −31.7% |
Today's value of $100 received in the future
- Discounted at 4%
- Discounted at 6%
A rate change of 2 percentage points equals 200 basis points — the unit in which rate moves are often reported.
#Does a rate cut always mean stocks go up?
No. Rates are only one input. Markets also react to why the Fed is moving: a cut in response to a weakening economy can arrive alongside falling profit expectations. Prices also tend to move on what investors expected before the announcement, not just on the decision itself. The Fed notes that many factors affect inflation and employment besides monetary policy [4], and stock prices respond to even more. This page does not forecast how markets will react to any decision.
Common beginner mistakes
Trading on the headline
By the time a decision is announced, much of it may already be reflected in prices. Reacting to the headline alone can mean buying high or selling low.
Treating the link as automatic
The Fed itself says its effects are not direct or immediate [4]. A rate move does not guarantee any particular market response.
Forgetting your own time horizon
Money needed in a year or two faces different risks from money invested for decades. Read risk tolerance and time horizon before changing a plan because of rates.
Ignoring the bond side of your portfolio
Rising rates lower the price of existing fixed-rate bonds [5]. If you hold bond funds, rates affect them too.
What's the bottom line?
Interest rates reach stock prices through two channels: they change how attractive stocks look against safer alternatives, and they change what future profits are worth today. Distant profits are the most rate-sensitive. None of this tells you where markets will go next — but it explains why a single Fed sentence can move them. Next, see what inflation is and how it is measured, the other half of the Fed's job.
Frequently asked questions
Does the Fed set mortgage and credit card rates?
Not directly. The Fed sets a target range for the federal funds rate. Lenders set their own loan rates, which tend to move with short-term rates and with expectations about future policy.
Why do markets move before the Fed announces anything?
Investors trade on what they expect the Fed to do. Longer-term rates and stock prices can shift weeks ahead as expectations change, so the announcement itself may move markets only by the amount that surprised people.
What is a basis point?
One hundredth of a percentage point. A 0.25 percentage point change is 25 basis points.
How often does the Fed decide on rates?
The FOMC holds eight regularly scheduled meetings a year [3]. Each scheduled decision is published in a statement on federalreserve.gov.
Sources
Grade A = primary source (regulator, government agency, official rulebook or the index provider's own documents). Numbers in brackets in the text point here.
- Board of Governors of the Federal Reserve System. Monetary Policy: What Are Its Goals? How Does It Work? (2026). Accessed 2026-10-03.A
- Board of Governors of the Federal Reserve System. Economy at a Glance — Policy Rate (2026). Accessed 2026-10-03.A
- Board of Governors of the Federal Reserve System. Federal Open Market Committee (2026). Accessed 2026-10-03.A
- Board of Governors of the Federal Reserve System. How does the Federal Reserve affect inflation and employment? (2026). Accessed 2026-10-03.A
- U.S. Securities and Exchange Commission. Interest rate risk — When interest rates go up, prices of fixed-rate bonds fall (Investor Bulletin) (2013). Accessed 2026-10-03.A
- Federal Reserve Bank of St. Louis — Page One Economics. Baseball and the $700 Million Bet on the Time Value of Money (2024). Accessed 2026-10-03.A
This page is general education, not personal financial, tax or legal advice. Figures in worked examples are hypothetical and calculated before taxes and fees unless stated. Rules and limits change; check the linked primary sources for the current version. How we check every page.
