From Ken Little,
Your Guide to Stocks.
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The direction of interest rate movement is of primary importance to the stock market. Stock investors watch for signs from the economy and regulators that may suggest which way interest rates will move in the future.

These tips are not always reliable over the long term, but may give investors an idea where interest rates are headed in the short run.

The Federal Reserve Open Market Committee, more commonly known as the Fed, sets key interest rates and the market reacts quickly to any changes it imposes.

Stocks React

More importantly, the market reacts to how it thinks the Fed is going to act even months before it meets.

Why this concern with interest rates?

Interest rates control the flow of money through the economy. When rates are low, consumer spending increases and businesses can borrow money for expansion and other needs at more affordable rates.

More money (cheaper money) in the economy encourages spending, which is good for businesses and consumers. In broad terms, an economy with an inexpensive flow of money creates new jobs.

Good for Stock Market

All of this is usually good for the stock market – up to a point.

That point is when the Fed gets nervous that the economy is growing too fast or hot and is in danger of pushing the inflation rate up.

When the Fed sees signs that inflation is on the rise or in danger of rising, it can put the brakes on by raising interest rates.

Higher interest rates slow the flow of money, making it more expensive for both consumers and businesses to borrow. This slowing effect reduces the chance of inflation, but it is also a drain on corporate profits and that hurts stock prices.

Fed meeting

Stock analysts comb economic data and Fed board meeting minutes for clues about the direction of interest rates. The stock market will often move in response to the latest reading on inflation.

Long-term investors should ignore the daily hand wringing over interest rates, but keep a watchful eye on the long-term picture. If you in the market to buy or sell, short-term fluctuations can be important in your timing.