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Newspapers write a lot about the central bank stopping "cheap money" in the US. What is that exactly and what are the implications for the stock market?

  • cost of borrowing money is low. AKA low interest rates – Darcys22 Jun 4 '13 at 4:18
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Companies with existing borrowings (where borrowings are on variable interest rates) or in the case with fixed interest rates - companies that get new borrowings - would pay less interest on these borrowings, so their cost will go down and profits up, making them more attractive to investors.

So, in general lower interest rates will make the share market a more attractive investment (than some alternatives) as investors are willing to take on more risk for potentially higher returns. This will usually result in the stock market rising as it is currently in the US.

EDIT: The case for rising interest rates

A central bank's purpose when raising interest rates is to slow down an economy that is booming. As interest rates rise consumers will tighten up their spending and companies will thus have less revenue on top of higher costs for maintaining existing borrowing (with variable rates) or new borrowing (with fixed rates). If rates are higher companies may also defer new borrowings to expand their business. This will eventually lead to lower profits and lower valuation for these companies.

Another thing that happens is that as banks start increasing interest for saving accounts investors will look for safety where they can get a higher return (than before) without the risk of the stock market.

With lowering profits and valuations, and investor's money flowing out of shares and into the money market, so will company share prices drop (although this may lag a bit with the share market still booming due to greed. But once the boom stops watchout for the crash).

  • A lot of corporations issue debt at a fixed rate, so changes in the underlying ffr won't change their interest payments directly unless they issue new debt (which they very well might). – John Bensin Jun 3 '13 at 22:18
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    In Australia we have what is called variable interest rate. Most people and companies borrow based on variable interest rather than fixed interest, but I do get your point as in the US most (if not all) borrowings are on fixed rates. – Victor Jun 3 '13 at 22:33
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    Every jurisdiction that I know of allows debt issuances that use variable interest rates; it's just not something a lot of corporations in the US do. I know quite a few people use variable rate mortgages, but not many corporations do (maybe ones that are issuing junk bonds, I don't know). Thanks for the clarification in your answer. – John Bensin Jun 4 '13 at 0:14
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    But the inverse of your argument is not true: high interest rates => stock market falling? – duedl0r Jun 5 '13 at 17:14
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    @Victor Twist operations are also extremely important, i.e. the distinction between short/long term rates. – John Bensin Jun 5 '13 at 23:28
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There are a couple of different things that could be referenced by "cheap money":

  1. The money supply itself - This is the Federal Reserve printing more money which could devalue the existing US dollars and thus make the dollars even cheaper since there would be more of them.

  2. Interest rates - Currently in the US interest rates are rather low which means that borrowers could possibly get good rates on that money thus making it relatively cheap. Compare current interest rates to the early 1980s and there is a major difference.

In terms of implications on the stock market, there are a couple that come to my mind:

  1. Investment options - With low interest rates, cash and bonds aren't necessarily yielding that much and thus some people may be more likely to invest elsewhere with stocks being an option. Thus, there may be some people that would rather invest in stocks than hold their investments in lower-yielding options.

  2. Corporate spending - If rates stay low, then for companies with good financial track records, they could borrow money to expand operations rather than sell more stock and thus there may be companies that borrow to grow so that they take advantage of these interest rates.

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Newspapers write a lot about the central bank stopping "cheap money" in the US. What is that exactly and what are the implications for the stock market?

An interest rate is simply defined as the price of money. So if money is cheap, it must mean there is a low interest rate compared to normal. If milk is cheap, we're comparing it to past prices or prices at competitors' stores. Same with money.

I don't think its fair to say just because the supply of dollars rises that the value of dollars will go down. Value or price is determined by supply and demand, not just supply. Its possible for the demand for dollars to be stronger than the rising supply, which would drive the price higher. A good example of this is to look at the value of the dollar recently. The Fed has been printing $85 billion per month, yet the value of them is going up compared to foreign currencies, gold, and just about everything. Why? Because the Fed has merely threatened to stop, but it hasn't stopped. That alone was enough to increase demand above supply. So if you want to know what will happen, take a look at what IS happening.

When cheap money ends, the value of the dollar will go up, interest rates will go up. This will be a drag on the economy. It will be more difficult for companies to show profits and earnings should decline. In addition, those who have grown accustom to the easy money and have over-leveraged themselves (ie REITs) could go bankrupt.

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