Two of the most crucial factors that influence the economic growth of a country are the stock exchange and interest rates. Changes in the interest rates affect the stock prices besides influencing government policies, risk management practices, and the assessment of financial securities. The relationship between interest rates and stock exchange prices determines the level of confidence to policymakers, investors, and other key players in the economy. This paper critically examines the impact of interest rates on the stocks of the United States and Saudi Arabia.
Interest Rate Impacts on the US and Saudi Stocks
The interest rate is defined from different viewpoints. It is the amount paid for the use of borrowed funds for a specified period (Alam, Md. Mahmudul, and Md. Gazi 43). From the perspective of a borrower, it is the cost of borrowing funds. In this case, it is often referred to as the borrowing rate (Al-Sharks and Marwan 74). For moneylenders, it is the fee imposed for loaning funds. The relationship between interest rate and the stock exchange is a key factor that determines the economic growth of any given country. Investors always look for favorable markets that are highly indicated by the two macroeconomic variables. If the banks pay high-interest rates, borrowers withdraw their capital from the stock market and deposit it into banks (Elhusseiny et al. 14). The withdrawal of capital from the general market results in decreased demand for shares. Additionally, the lending interest rate goes up thereby causing a decrease in investor confidence. The relationship is inverted. Contractionary monetary policies usually result in the hiking of the interest rates. Raising the interest rates affects the stock market return negatively. The value of equity decreases with the rising interest rates as prescribed by the dividend discount model. High interest increases the cost of doing business for investors. Low-interest rates boost the stock market (Willis, Jonathan, and Cao 24).
In the United States, changes in monetary policies such as the Federal Funds Rates (FEDs) greatly affect the stock prices (Jochem and Stefan 268). Research indicates that highly cyclical industries react more sensitively to the changes in interest rates. These industries fall into technology, communication, and cyclical consumer commodity. They are highly affected by monetary policies relative to others sectors. Figure 1.0 shows the interest rates and inflation effects on the US Stock market.
Different theories are utilized to explain the responsiveness of the US stocks to changes in interest rates. For instance, the Keynesian theory that uses the sticky price model posits that the stock prices will not respond to monetary policies such as the increase or decrease of interest rates in the short run. The interest rate adjusts to accommodate equilibrium in the financial market (Al-Sharks and Marwan 74). According to this theory, an announcement of increased money supply in the US economy lowers the stock prices for the two chief reasons. First, peoples’ speculations on a higher future interest rate and lower sales stemming from the anticipated lower economic activity (Garg 2). The Keynesian theorists reveal that an inverted relationship exists between stock prices and money supply (Elhusseiny et al. 14). However, it anticipates a positive relationship between changes in the Feds and stock prices. The Fed controls the monetary policies including interest rates in a bid to check inflation (Willis, Jonathan, and Cao 24). The increase in the federal funds rate prompts banks to hike the interest charges on their customers’ mortgage and credit services among others. Consumer spending remains conservative since the disposable income shrinks (Garg 2). For this reason, consumers spend less discretionary money thereby affecting business revenues and profit margins (Jochem and Stefan 269).
The Saudi Arabia stock market is allegedly opening up for foreign investors. This move has been regarded as a game-changer in the region. While foreign investors look forward to storming the stock market in the KSA, factors affecting the stocks such as interest rates remain critical variables for consideration (Alam, Md Mahmudul, and Md Gazi 43). Increasing the interest rates can derail the prospective foreign investments in the country while lowering them can create a favorable environment for foreign traders. Figure 1.1 shows the KSA stock exchange index that investors need to scrutinize closely before entering the stock market.
The stock markets for the US and Saudi Arabia fluctuate depending on changes in several economic variables such as consumer price index, foreign exchange rates, and oil prices. The monetary policy of any country revolves around regulating money supply through the interest rates that in turn affect the stock markets. This paper has provided an in-depth insight into the impact of changes in the interest rates on the US and Saudi market stocks. The theoretical explanation is also provided to elaborate the behavior of stock markets with changing interest rates. Investors scrutinize the country’s potential for investments from a close look at the interest rates. The Saudi Arabian stock market that opens for foreign investments is likely to be affected by interest changes.
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