What Are Interest Rates and Why Markets React

Interest rates influence almost every part of the financial system. When rates change, borrowing costs move, savings returns adjust, and asset prices often react quickly. This is why markets pay close attention to interest rate decisions and expectations.

For investors, understanding interest rates in investing is essential. Rates help explain why stocks rise or fall, why bonds move the way they do, and why certain sectors perform better at different times.

This guide explains what interest rates are, how they work, and why markets react so strongly to changes in rates.

What Are Interest Rates?

Interest rates represent the cost of borrowing money or the return earned on savings, expressed as a percentage.

In simple terms, interest rates answer this question: How much does it cost to use money over time?

When you borrow money, you pay interest. When you save or lend money, you earn interest. The level of interest rates affects decisions made by consumers, businesses, and investors.

How Do Interest Rates Work?

Interest rates exist across different parts of the economy, but a few key concepts matter most for markets.

1. Central banks influence interest rates

Central banks, such as the US Federal Reserve, set policy rates that guide short term borrowing costs in the economy.

When central banks raise rates, borrowing becomes more expensive. When they lower rates, borrowing becomes cheaper.

2. Market rates adjust across the economy

Changes in policy rates influence other rates, including:

• Bank loan rates

• Mortgage rates

• Government bond yields

These shifts affect spending, investment, and financial conditions.

3. Rates reflect inflation and growth expectations

Interest rates are closely linked to inflation and economic growth. Higher inflation expectations often lead to higher rates. Slower growth expectations often push rates lower.

Why Markets React to Interest Rate Changes?

Markets react to interest rates because rates affect future cash flows, risk appetite, and economic activity.

They affect company profits

Higher interest rates increase borrowing costs for companies. This can reduce profits, especially for businesses that rely heavily on debt.

Lower rates reduce financing costs, which can support investment and earnings growth.

They influence stock valuations

Stock prices reflect expectations of future cash flows. When interest rates rise, future cash flows are discounted more heavily, which can put pressure on valuations.

When rates fall, valuations often look more attractive.

They shift investor preferences

Rising interest rates make safer assets like bonds more attractive relative to stocks. Falling rates often push investors toward riskier assets in search of returns.

They signal economic conditions

Rate hikes often signal concerns about inflation or an overheating economy. Rate cuts often signal slowing growth or economic stress.

Markets react not just to the rate change itself, but to what it suggests about the future.

Interest Rates and Different Asset Classes

Interest rates do not affect all assets equally.

Stocks
Growth oriented stocks are often more sensitive to rate changes because more of their value comes from future earnings.

Bonds
Bond prices generally move opposite to interest rates. When rates rise, existing bond prices tend to fall.

Currencies
Higher interest rates can attract capital and support a currency. Lower rates can have the opposite effect.

Real assets
Assets like real estate can be sensitive to interest rates due to financing costs and yield comparisons.

Interest Rates vs Inflation

Interest rates and inflation are closely connected, but they are not the same.

Interest rates are nominal. Inflation reduces the real value of returns. If interest rates are lower than inflation, real returns can be negative even if nominal returns look positive.

This relationship is why investors often watch real interest rates, not just headline rates.

Why Interest Rate Expectations Matter

Markets often move before interest rates actually change.

Investors price in expectations based on:

• Central bank communication

• Economic data

• Inflation trends

As a result, markets may react strongly even if rates remain unchanged, simply because expectations shift.

Conclusion

Interest rates represent the cost of money and play a central role in how markets behave. They influence profits, valuations, and investor behavior across asset classes.

By understanding how interest rates work and why markets react to them, investors can better interpret market movements and avoid reacting blindly to headlines.

If you want to explore how interest rates affect US stocks and ETFs in real markets, you can do so through the Gotrade app. Fractional shares make it easier to observe market reactions and build experience gradually.

FAQ

What are interest rates in simple terms?
Interest rates are the cost of borrowing money or the return earned on savings, expressed as a percentage.

Why do stock markets react to interest rate changes?
Interest rates affect company profits, valuations, and investor preferences, which influences stock prices.

Do rising interest rates always hurt stocks?
Not always. Some sectors can perform well, especially if rate increases reflect strong economic growth.

Why do markets react before rates actually change?
Markets price in expectations. Changes in outlook can move prices even before any official decision.

Reference:

• Investopedia, Interest Rates, 2026.

• Rosenberg Research, The Impact of Interest Rates on the Economy, 2026.

Disclaimer

Gotrade is the trading name of Gotrade Securities Inc., which is registered with and supervised by the Labuan Financial Services Authority (LFSA). This content is for educational purposes only and does not constitute financial advice. Always do your own research (DYOR) before investing.