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Bloopers & Blunders:
Interest Rate Hike and Stock Prices

Quotation

"With fears of an interest rate hike fading, Wall Street said goodbye to the second quarter Friday on a powerful rally in the technology sector and bond market.

The Nasdaq Composite again posted the most impressive gain, rising 19.01 points to 1,185.02.

. . .

The Dow Jones industrial average shrugged off the strength in the bond market and sank 22.90 points to 5,654.63." (CNNfn, June 28, 1996)

Explanation

Why did fears and the strength in the bond market have different impacts on the Nasdaq market and on the Dow Jones? Stocks, in general, react negatively to increases in interest rates (i.e., stock prices and interest rates are negatively correlated). Thus, fading investors’ fear of an interest rate hike should, other things being equal, boost stock prices.

There are a number of plausible rationalizations for having these two markets reacting in the opposite direction: market prices include an unpredictable random element; in addition there was news impacting these two groups of stocks in opposite directions. Since there wasn’t other major news on that day, the "random element" is probably the most likely explanation for the opposite movement of these two stock groups.


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