Question

On April 29 2020, the major stock indexes rose amid promising results for a COVID-19 vaccine and reassurance from the U.S. Federal Reserve Bank that it would use all its tools to help the economy. Why does the monetary policy have a strong influence on the share market?(the answer is expected to be around 200 words.)

Answer 1

Reasons as to why monetary policy have strong influence over share markets is because of the following reasons:

1. Ultra low interest rates : Fed has used all types of conventional and unconventional monetary policy tools to keep short term interest rate to zero percent, which then have effect on the high end of the curve and interest rates for long maturity bond tends to fall. This interest rate decrease will reduce the discount rate used to calculate value of shares thereby supporting the equity markets valuations.

2. Bond market effect: As Fed has reassured markets that interest rates will remain low for months or even years to come then this means that bond market becomes less attractive to investors because bonds are now priced high because of low interest rates and now money moves from bond markets to equity markets to seek higher returns. This shift of capital from bond markets to equity markets leads to increase in valuations across equity markets.

3. Unlimited quantitative easing: Fed has announced unlimited quantitaive easing and therefore it has purchased various asset classes like mortgage loans, collateralized loan obligations, high grade bonds, high yield bonds etc. This massive monetary stimulus provided necessary funding to the business which are operating on brink of their collapse and ensures survival of them. Therefore this type of support from fed assures markets that their money in stocks is indirectly backed by fed's assurance to markets which then leads to calming effect on equity investors.

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