How the Federal Reserve Banking System is Tied to the Stock Market

The central bank of the US, the Federal Reserve (the Fed), is indirectly tied to the stock market through its influence over economic conditions, interest rates, and overall financial stability. While the Fed's purported primary mandate is to manage inflation, unemployment, and ensure the stability of the financial system, its actions have significant effects on the stock market. Here’s how the Fed is tied to the stock market.

The Fed controls the federal funds rate, which is the interest rate at which banks lend to each other overnight. This rate serves as the foundation for other interest rates throughout the economy, including those for mortgages, business loans, and bonds.

When the Federal reserve lowers interest rates, borrowing becomes cheaper, which encourages businesses to expand and consumers to spend. This often boosts corporate earnings of publicly traded companies, which can drive stock prices higher. Lower interest rates also make bonds and savings accounts less attractive relative to stocks, pushing investors and savers to seek higher returns in the stock market. As lower interest rates encourage consumers to take on debt and spend more on goods, including those produced by such publicly traded corporations, therefore boosting stock prices, they simultaneously make stocks an appealing option for consumers to save their unspent money. This is the reason it’s referred to as a house of cards. While the Fed’s policies create short-term economic growth and stock market gains, the underlying system is inherently unstable. The expansion fueled by artificially low interest rates is not based on real savings or productivity but rather on inflated credit (printed or digitally created new money) and speculative investments.

(Conversely, when the Fed raises interest rates to reduce inflation, borrowing costs increase, which can slow economic growth, reduce corporate profits, and lead to lower stock prices.)

Publicly traded companies benefit from the stock market being tied to the Federal Reserve in various ways, including lower borrowing costs, easier access to capital, improved stock valuations, and greater market stability. The Fed’s policies, especially during times of economic downturn or instability, encourages an environment for corporate growth, consumer spending, and investor confidence, all of which fuel stock market performance. As a result, these companies can grow their earnings, boost shareholder value, and enhance their competitiveness in the marketplace.

The Federal Reserve's inflationary policies, while benefiting large publicly traded companies, creates significant challenges for smaller businesses, particularly in terms of access to financial capital and competition. Here’s how smaller companies face difficulties in competing with larger corporations in this environment.

1.) Impact of Lower Interest Rates: When the Federal Reserve lowers interest rates by creating new money, it becomes cheaper for companies to borrow money. Publicly traded companies receiving the newly created money buy up scarce resources, driving up their prices higher than they would have been otherwise, making them more expensive for smaller companies competing for the use of the same resources.

2.) Larger Companies Have Better Access: Large, publicly traded companies have easier access to capital markets, especially during periods of low interest rates. They can issue bonds, raise equity, or secure loans at favorable terms due to their size, creditworthiness, and established track record. In contrast, smaller businesses often lack the same access to capital markets or cannot issue bonds and shares on the scale large companies can. They are more reliant on traditional bank loans, which may not be as easily available or offered at the same favorable rates. since smaller companies are perceived as higher risk by lenders and investors, leading to higher interest rates on loans and less favorable terms. This puts them at a competitive disadvantage.

3.) Consolidation of Industries and Market Power: The availability of cheap capital to larger companies can lead to increased consolidation in industries, where a few large firms dominate market share. This makes it hard for smaller companies to break into the market or compete effectively because larger firms can undercut them on price, expand more quickly, or invest in more innovative technologies.

4.) Political and Regulatory Influence: Large corporations have significant lobbying power and can influence policies and regulations that favor their interests, creating barriers to entry for smaller companies. They can also lobby for favorable tax treatment or regulatory environments, which small businesses may struggle to navigate or afford.

5.) Regulatory Costs: Large firms have more resources to comply with complex regulations or to shape those regulations in their favor. Smaller companies may find it difficult to bear the same regulatory burden, limiting their ability to grow or compete effectively.

6.) Bailouts and Favorable Treatment: Large companies, especially those deemed “too big to fail,” often receive preferential treatment during economic downturns. For example, during financial crises, large firms may receive government bailouts or other forms of support, while small businesses are left to navigate the crisis on their own.