The Federal Reserve sets monetary policy by influencing the federal funds rate, which is the overnight interest rate charged by financial institutions to each other. This triggers changes in other interest rates, foreign exchange rates and overall economic conditions. While interest rates affect stakeholders--investors, employees, suppliers and customers--in different ways, the impacts are real and felt by everybody.
Employees are affected because interest rates influence general economic conditions. Rising rates can lead to a slowdown in the economic growth rate, which impacts sales and profits; lower rates can have the opposite impact. Changes in rates impact a company’s interest expenses, which also affects profits. A profitable company is likely to hire more employees and increase compensation levels, while the opposite is generally true for an unprofitable company. Profitability trends tend to impact share prices, which affect employees who hold stock options or participate in stock purchase plans.
Stockholders are affected because interest rate changes influence stock markets--they tend to rise when rates fall and fall when rates rise. Markets behave this way because rate changes impact economic conditions which, in turn, impact profitability. Rising rates, for example, can signal price inflation, and higher raw material and labor costs lead to lower profits. When rates fall, inflation fears dissipate and markets tend to rise as there is renewed optimism about the prospects for sales and profit growth. Bondholders are impacted in two ways: First, bond prices move in an opposite direction to rates--rising rates lead to lower bond prices and vice versa. Secondly, profitability levels directly impact a company’s ability to make the interest payments on its outstanding bonds.
Suppliers provide the raw materials used to manufacture products and provide services. Interest rate changes impact the demand for raw materials and, thus, their prices. Energy prices rose dramatically in the mid-2000s as strong growth in China and India--both energy importers--drove demand up. Conversely, the 2008 financial crisis drove down energy and other raw material prices as the global recession dampened demand. A supplier of energy and other commodity-related raw materials will see profit margins vary according to demand. For example, a supplier of roof shingles to home builders will likely see demand and profits fall as rates rise because fewer homes are usually sold as mortgage rates rise. Conversely, he is likely to see rising sales and profits as rates fall and more people look to buy their first homes or move into bigger homes.
Customers are affected because interest rates impact unemployment levels and borrowing costs. Rising unemployment levels lead to reduced customer confidence, while the reverse is true when jobs are abundant. Changes in borrowing costs, such as car loan and credit card rates, impact what a customer can afford. For example, if rates rise, fewer people tend to trade in their cars. Similarly, when customers do not feel good about their job prospects, they are unlikely to consider buying a new car.
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.