How does the Federal Reserve's interest rate hike affect the stock and bond markets?

Hey, that's a great question, and one many people get confused about. Let me break it down for you in plain language, so you're sure to understand.

The Fed raising interest rates sounds very sophisticated, but you can actually think of it as tightening the "master faucet" for all the money in society. The price of the water flowing from this "master faucet" is the interest rate. Raising interest rates simply means making money more expensive.

Once this action is taken, the water in the two ponds – the stock market and the bond market – will change significantly.

Impact on the Stock Market: Usually Negative (Bad News)

Interest rate hikes hit the stock market in multiple ways, like a combination punch.

Increased Borrowing Costs for Companies
- Think about it: for a company to grow, doesn't it need to borrow money to buy equipment, build factories, and fund R&D? Now that interest rates are higher, the cost of borrowing goes up, which eats into the company's profits. When profit expectations drop, stock prices naturally become less attractive.
Reduced Consumer Spending
- Interest rate hikes don't just affect businesses; they impact ordinary people too. Your mortgage, car loan, and credit card interest rates might all go up, meaning you have more to pay each month and less disposable income for spending. If people aren't spending much, listed companies' products don't sell well, revenues decline, and their stock prices will naturally be affected.
Decreased "Attractiveness" of Stocks
- This is the most crucial point. When interest rates are very low (e.g., only 1%), you get almost no return by putting your money in the bank, so you're more willing to invest it in the stock market to chase higher returns.
- But now the Fed has raised rates; for example, risk-free Treasury yields have climbed to 4%-5%. At this point, you'll start to weigh your options: "Why should I risk losing money by trading stocks? Wouldn't it be much better to buy government bonds and steadily earn 5% interest every year?"
- As more and more people think this way, they'll pull money out of the stock market and switch to buying bonds or simply putting it in the bank. With less money in the stock market, stock prices naturally tend to fall. This is like a "siphoning effect."

Impact on the Bond Market: A Simple, Direct "Seesaw Effect"

The relationship between the bond market and interest rates is very direct, like a seesaw: when interest rates rise, bond prices fall.

This might seem counter-intuitive, so let me give you an example:

Scenario 1 (Before Rate Hike): Last year, you spent 1000 yuan to buy a government bond with a coupon rate of 2%, meaning it gives you 20 yuan in interest each year.
Scenario 2 (After Rate Hike): Now the Fed has raised interest rates, and newly issued government bonds of the same type have a coupon rate of 5%. If someone spends 1000 yuan to buy a new bond, they get 50 yuan in interest each year.
Here's the problem: At this point, if you wanted to sell your old bond, which only gives 20 yuan in interest annually, could you still sell it for 1000 yuan? Definitely not! Because no one would be foolish enough to pay the same amount of money for a product that offers lower interest.
What can you do? You can only sell it at a lower price. For example, if you lower the price to 950 yuan, then for the next buyer, they spend 950 yuan to buy it and get 20 yuan in interest each year. Their yield would be higher than the original 2%, and it would finally have some competitiveness compared to the newly issued 5% government bonds.

So you see, when new interest rates (5%) rise, the price of the existing, lower-rate (2%) bonds you hold must fall. This is the "seesaw effect" between interest rates and bond prices.

To Summarize

Fed Raises Interest Rates (Tightens the Faucet) → Money Becomes More Expensive
- For the Stock Market: It becomes harder for businesses and individuals to borrow, and people spend less, making it tougher for companies to earn profits; at the same time, returns from saving/buying bonds become more attractive, leading to funds flowing out of the stock market. Result: Stock market tends to fall.
- For the Bond Market: Newly issued bonds offer higher interest, making previously issued older bonds less appealing. To remain competitive, the prices of old bonds must fall. Result: Bond prices fall.

Of course, the market is very complex. Sometimes the market anticipates a rate hike in advance, and when the news is officially announced, it might be a "sell the rumor, buy the news" scenario, leading to a rise. However, the fundamental logic behind it is what has been explained above.

I hope this plain language explanation helps you understand it clearly!