Page 490 - THE MARKET WHISPERER

486 PART 15 - Special Occasions, Special Rules

Interest Rate Day

The announcement of the periodic interest rate is the most important of
decisions and has immediate, strong impact not only on the US markets,
but worldwide. Interest rate decisions are known for determining impact

on stock market behavior for both the short and long terms. The decision

is announced on fixed dates eight times throughout the year, when the
Federal Open Market Committee (FOMC) meets. The FOMC sets the short-
term interest and thereby influences the price of credit, and thus the entire

market.
Interest, as we know, is the price of money. The higher the interest, the

more expensive money is. The lower the interest, the cheaper money is.

When money is cheap, it pays to “buy” money. We do this by taking loans.

When money is expensive, it pays to “sell” money, by giving loans. A savings

account is a way of you lending money to the bank. Simple, right?

So how is all this connected to the market? That, too, is simple. When

money is cheap, the return or yield on money loans (savings) is low. People

with money who fear its value will be undermined (known as inflation)

turn to other investment channels such as real estate and the stock market,
in the hope that they will gain better returns. Cheap money means more
money available to the stock market, which translates as more buyers,

which means rates go up. In fact, it is even worth borrowing money from

the bank to invest in other channels such as stocks and real estate. In

addition, when money is cheap, the amount of money available is greater

and is therefore worthwhile putting to use, which drives the economy and

increases the profits of companies traded on the stock exchange.

SMART On interest rate decision day, we prefer trading only in the
MONEY first two hours. After that, the market waits for the decision.
In limbo, it shows very low volatility. Immediately following
the announcement, volatility will often be too high for
trading.

So if everything looks so good, why is interest not kept constantly low?
Cheap money can cause two eventualities. First, it can lead to inflation:
that is, raised prices deriving from the undermined value of money which

is cheap. The second is the formation of a bubble, a situation where the

prices of real estate and securities swell disproportionately to their real

value.
When the Federal Reserve Bank raises interest, it increases savings and