Fed: Surprise rate cuts boost markets

Reuters got hold of a new and currently unreleased research paper by the New York Fed which links the unexpected Interest Rate cuts by the Fed and stock prices. According to this new paper, if the market does not anticipate a 25 basis point cut, share prices increase by 1 percent. Authors of the paper Ben Bernanke and Kenneth Kuttner are not precisely sure why the market reacts the way it does but they feel it probably has to do with expected future returns or future dividends.

I think the link is probably quite a bit more simple. When the Fed wants to lower interest rates, it buys securities on the open market (To see why read "What is deflation"). The investors who held the bonds don't just sit on the money, they turn around and invest it elsewhere. Some of that money should see it's way toward the stock market, causing stock prices to rise. I'd like to hear your take on it, so please send me your thuoghts by using the feedback form

Important Links

• To learn more about how Fed reactions to inflation and deflation influence interest rates see "What is deflation".
• To learn about the link between exchange rates and interest rates see my "Guide to Exchange Rates".