Why interest rates move stock prices
The link between the Fed and your portfolio is not a mystery. It is arithmetic.
When the Federal Reserve raises interest rates, stock prices tend to fall, and when it cuts, they tend to rise. Financial television treats this as market psychology. Mostly, it is arithmetic.
A share of stock is a claim on a company's future cash flows. To decide what that claim is worth today, investors discount those future dollars back to the present, and the discount rate they use is anchored to the yield on safe government debt. When a 10-year Treasury pays 1%, a dollar of corporate profit arriving in 2035 is worth a lot today. When the same Treasury pays 5%, that future dollar is worth meaningfully less, because you could have earned 5% a year in the meantime without taking any business risk.
Duration: why growth stocks swing hardest
The stocks hit hardest by rising rates are the ones whose profits sit furthest in the future. A utility earning steady cash today loses a little value when discount rates climb. A software company priced on profits it will not earn until the 2030s loses much more, for the same reason a 30-year bond falls further than a 2-year bond when yields rise. Bond investors call this sensitivity duration, and it applies to equities just as well.
The competition channel
Rates work on stocks through a second door: competition for your money. When cash and short-term Treasuries yield close to zero, stocks are, in the famous phrase, the only game in town. When a money-market fund pays 5% with essentially no risk, the bar for owning equities rises. Some money leaves, prices adjust, and expected future returns reset higher to compensate.
The earnings channel
Finally, rates act on the cash flows themselves. Higher borrowing costs squeeze corporate margins, cool the housing market, and slow consumer spending on credit. That is the intended mechanism of monetary tightening, and it means a rate hike can lower both the value of each future dollar and the number of future dollars.
None of this makes markets predictable — rate expectations are already priced in long before the Fed acts, which is why stocks often rally on a hike that was fully anticipated. But it does make them legible. When you see equities lurch after an inflation report, you are not watching mass emotion. You are watching a repricing of the discount rate, applied to every future dollar at once.