Foundations

Interest rates

Warren Buffett called interest rates "gravity" for asset prices. It's a good image: one number, set in a room by a central bank, quietly pulling on bonds, stocks, houses and the loan on your car. Here's how the pull works.

The one number

Central banks — the Fed, the ECB, and their peers — set a short-term policy rate: the price of borrowing money at the safest, shortest end of the system. They move it to cool an economy down (raise rates) or warm it up (cut rates). Almost every other interest rate in the economy takes its cue from that anchor.

Why it moves everything

Bonds — the direct hit. A bond pays a fixed stream of cash. If new bonds start paying more because rates rose, your older, lower-paying bond is worth less to anyone who could buy the new one instead. So its price falls. This is the see-saw at the heart of fixed income: rates up, existing bond prices down, and vice versa — and the longer the bond, the harder it swings.

Stocks — the discount effect. A share is worth the future cash a company will throw off, translated back into today's money. That translation uses an interest rate: the higher the rate, the less those far-off future profits are worth now. When rates rise, every valuation gets marked down a little — and companies whose profits are mostly far in the future (fast-growing, "story" stocks) get marked down the most.

Everything else. Mortgages, credit cards, business loans and savings accounts all reprice off the same anchor. Higher rates make borrowing dearer and saving in cash more rewarding — which is exactly how a central bank slows things down.

The mechanism in one line: higher rates make safe cash pay more, so every riskier or more-distant payoff has to compete with that — and gets repriced lower until it does.

The honest caveats

Markets look ahead. Prices tend to move on the expected path of rates, not the announcement itself. By the time a hike is news, it's often already in the price.
Rates aren't the only force. Earnings, inflation, and plain sentiment all push too. "Rates went up so stocks must fall today" is a story, not a law.
Nobody reliably predicts them. Forecasting the exact path of rates is a game even the professionals lose — see our why-we-exist page on how badly market forecasts score.

The short version

Central banks set one policy rate; almost every other rate follows it.
Bond prices move opposite to rates — and longer bonds move more.
Higher rates discount future profits harder, which pressures stocks — growth stocks most.
Markets price the expected path, and no one forecasts it reliably — so "rate-timing" is a trap.

Not advice — a reminder. This explains how rates transmit through markets, not what to do about them. Trying to trade rate moves is exactly the kind of prediction that usually disappoints. For planning around your own situation, a fee-only fiduciary adviser is the place to go.

Sources

Federal Reserve & European Central Bank — explainers on the policy rate and monetary-policy transmission.
Standard finance texts on bond pricing (the inverse price–yield relationship and duration) and discounted cash-flow valuation.
See also our evidence page on the poor track record of market and rate forecasting.