The Effect of Changes in the Federal Funds Rate on Stock Markets: A Sector-Wise Analysis

The federal funds rate is an indicator of monetary policy that investors in the stock market scrutinize very closely. This paper determines the relationship between changes in the federal funds rate and sector stock indexes. The paper goes on to determine why particular sectors are more sensitive to interest rate changes than others. Weekly returns of the Dow Jones ICB classified financial, energy, utilities, materials, industrials, consumer goods, consumer services, information technology, healthcare and telecommunications sectors are analyzed using separate OLS regression models for each sector. The results show that the utilities, financials, telecom and basic materials sectors are the most interest rate sensitive in that order and that the relationship exhibited between the stock price and the federal funds rate is positive. I conclude by attributing the positive relationship to sector specific demand and supply effects. This article is available in Undergraduate Economic Review: http://digitalcommons.iwu.edu/uer/vol4/iss1/2 Kunaey Garg Advanced Research Seminar Final Paper The Effect of Changes in the Federal Funds Rate on Stock Markets: A Sector-wise Analysis. By: Kunaey Garg and Dr. Margaret Chapman, Illinois Wesleyan University Abstract: The federal funds rate is an indicator of monetary policy that investors in the stock market scrutinize very closely. This paper determines the relationship between changes in the federal funds rate and sector stock indexes. The paper goes on to determine why particular sectors are more sensitive to interest rate changes than others. Weekly returns of the Dow Jones ICB classified financial, energy, utilities, materials, industrials, consumer goods, consumer services, information technology, healthcare and telecommunications sectors are analyzed using separate OLS regression models for each sector. The results show that the utilities, financials, telecom and basic materials sectors are the most interest rate sensitive in that order and that the relationship exhibited between the stock price and the federal funds rate is positive. I conclude by attributing the positive relationship to sector specific demand and supply effects. The federal funds rate is an indicator of monetary policy that investors in the stock market scrutinize very closely. This paper determines the relationship between changes in the federal funds rate and sector stock indexes. The paper goes on to determine why particular sectors are more sensitive to interest rate changes than others. Weekly returns of the Dow Jones ICB classified financial, energy, utilities, materials, industrials, consumer goods, consumer services, information technology, healthcare and telecommunications sectors are analyzed using separate OLS regression models for each sector. The results show that the utilities, financials, telecom and basic materials sectors are the most interest rate sensitive in that order and that the relationship exhibited between the stock price and the federal funds rate is positive. I conclude by attributing the positive relationship to sector specific demand and supply effects. 1 Garg: The Effect of Changes in the Federal Funds Rate on Stock Markets: Published by Digital Commons @ IWU, 2008