# Interest Rates

> Interest rates are the price of money and a key driver of asset prices. Learn policy vs market rates, real rates and how rates move stocks, bonds and currencies.

Source: https://learn.tradelabsai.com/macro/interest-rates/  
Track: Economics and Macro · Level: Intermediate · Updated: 2026-10-03  
Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice.  
Cite as: TradeLabs Learn, "Interest Rates", https://learn.tradelabsai.com/macro/interest-rates/

Interest rates are the price of borrowing money and the reward for saving it. They influence almost every financial market: bond prices move inversely to yields, stock valuations depend on discount rates, currencies respond to rate differences between countries and commodities react to financing costs and growth expectations. Central banks set short term policy rates, while markets determine longer term rates based on expectations, inflation and risk. Understanding rates is essential for any trader.

## Types of interest rates

| Rate | Set by | Examples |
|---|---|---|
| Policy rate | Central bank | Federal funds rate (US), ECB deposit rate, Bank of England Bank Rate |
| Overnight market rates | Money markets | SOFR (US), SONIA (UK), €STR (euro area) |
| Government bond yields | Bond market | 2 year, 10 year, 30 year Treasury yields |
| Credit rates | Market plus credit risk | Corporate bond yields, mortgage rates |
| Real rates | Nominal rate minus expected inflation | TIPS yields |

See [Central Banks Explained](https://learn.tradelabsai.com/macro/central-banks-explained/) and [Treasury Bills, Notes and Bonds](https://learn.tradelabsai.com/bonds-credit/treasury-bills-notes-and-bonds/).

## Nominal vs real rates

```
real interest rate ≈ nominal interest rate - expected inflation
```

Real rates matter most for asset prices. A 5% nominal rate with 2% inflation (3% real) is tight; a 5% rate with 8% inflation (minus 3% real) is very loose. See [Inflation](https://learn.tradelabsai.com/macro/inflation/).

## How rates affect markets

| Asset | Effect of higher rates |
|---|---|
| Bonds | Prices fall; longer bonds fall more. See [Duration](https://learn.tradelabsai.com/bonds-credit/duration/) |
| Stocks | Valuations fall as future cash flows are discounted more; growth stocks most affected. See [WACC and Cost of Equity](https://learn.tradelabsai.com/fundamentals/wacc-and-cost-of-equity/) |
| Currencies | Higher rates relative to other countries tend to strengthen a currency. See [Interest Rate Differentials](https://learn.tradelabsai.com/forex/interest-rate-differentials/) |
| Gold | Higher real rates usually weigh on gold. See [Gold](https://learn.tradelabsai.com/commodities/gold/) |
| Real estate | Higher mortgage rates reduce affordability and property values |
| Commodities | Higher financing costs; slower growth can reduce demand |
| Cash | Earns more; becomes more attractive relative to risky assets |

**Example: Rates and a growth stock**
A company expects to earn $10 per share in profit, starting ten years from now. At a 6% discount rate, $10 received in ten years is worth about $5.58 today; at 9%, about $4.22. A three point rise in discount rates reduces that future value by about 24%. This is why technology and other long duration growth stocks fell sharply in 2022 as rates rose. See [DCF Valuation](https://learn.tradelabsai.com/fundamentals/dcf-valuation/).

## How central banks influence rates

- **Policy rate changes** directly affect short term borrowing costs.
- **Forward guidance** shapes expectations for future rates.
- **Balance sheet policy:** buying bonds (quantitative easing) lowers long term yields; shrinking holdings (quantitative tightening) does the opposite. See [Quantitative Easing and Tightening](https://learn.tradelabsai.com/macro/quantitative-easing/).

## Market pricing of future rates

Traders read expected policy paths from:

- **Fed funds futures and SOFR futures,** which imply the probability of rate changes at each meeting.
- **Overnight index swaps (OIS).**
- **The 2 year Treasury yield,** which closely tracks expected policy rates over two years.

Tools such as CME FedWatch translate futures prices into meeting by meeting probabilities.

## The neutral rate

Economists talk about the neutral interest rate, the rate that neither stimulates nor restrains the economy, sometimes called r star. It cannot be observed directly, and estimates vary. Whether policy is above or below neutral shapes expectations for growth and inflation.

## Historical context

US policy rates were near zero after the 2008 crisis and again in 2020, then rose to 5.25% to 5.50% by 2023. In the early 1980s, under Fed Chair Paul Volcker, the federal funds rate exceeded 19% to break high inflation. Long periods of low rates in the 2010s supported high valuations for stocks and bonds.

## Frequently asked questions

### How do interest rates affect stocks?

Higher rates raise discount rates and borrowing costs, which tends to lower stock valuations, especially for growth companies with distant cash flows.

### What is the difference between nominal and real interest rates?

Nominal rates are quoted rates; real rates subtract expected inflation and show the true cost of borrowing or return on saving.

### How can I see what the market expects for interest rates?

By looking at fed funds and SOFR futures, overnight index swaps and short term Treasury yields, or tools like CME FedWatch.

Next, learn how central banks work in [Central Banks Explained](https://learn.tradelabsai.com/macro/central-banks-explained/).

## Continue learning

- Next lesson: [Central Banks Explained](https://learn.tradelabsai.com/macro/central-banks-explained/)
- Previous lesson: [Recession Indicators](https://learn.tradelabsai.com/macro/recession-indicators/)
- Related: [Recession Indicators](https://learn.tradelabsai.com/macro/recession-indicators/): Recession indicators like the yield curve, the Sahm rule and leading indices have warned of past downturns. Learn how each works, its record and its limits.
- Related: [Central Banks Explained](https://learn.tradelabsai.com/macro/central-banks-explained/): Central banks set interest rates and manage money to control inflation and support growth. Learn their mandates, policy tools, communication and market impact.
- Related: [The Federal Reserve and the FOMC](https://learn.tradelabsai.com/macro/the-federal-reserve-and-the-fomc/): The Federal Reserve sets US monetary policy through the FOMC. Learn how meetings work, the dot plot, statements and press conferences, and how Fed days trade.
- Related: [Yield Curves](https://learn.tradelabsai.com/bonds-credit/yield-curves/): The yield curve plots bond yields across maturities. Learn normal, flat and inverted curves, what drives them and why inversions have signalled recessions.
- Related: [Interest Rate Differentials](https://learn.tradelabsai.com/forex/interest-rate-differentials/): The gap between two countries' interest rates is a major driver of exchange rates. Learn why differentials move currencies, how to track them and their limits.
- Related: [WACC and Cost of Equity](https://learn.tradelabsai.com/fundamentals/wacc-and-cost-of-equity/): WACC blends the cost of equity and the after tax cost of debt into a discount rate. Learn CAPM, beta, the equity risk premium, a worked example and common pitfalls.