In the past, The Fed typically raised interest rates to help balance the money supply. When the economy is good and unemployment is low, the Fed raises rates to prevent an over-tightening of the money supply. This is traditionally how inflation works and when this happens it is actually a sign of health. Commodity prices tended to soar because there was increased demand of natural resources. When the Fed raises rates so high that is not in the best interest of investors to borrow money, that causes flight from equities into other instruments such as fixed income because bond prices are low and yields are high. This is where the Fed had to respond by lowering rates until borrowing money became attractive again and the cycle repeated.
What we have right now is a historic unprecedented downtrend in interest rates, which is partly due to the Fed's response to deflationary pressure, the credit crisis, and real unemployment. aka "quantitative easing." Money is cheaper than ever. But without real economic growth to drive rates higher, the only logical place to put excess liquid assets is the stock market. This has caused the market to continue ever higher, causing a rift in the correlation. Until the fed feels that it needs to tighten the money supply, this pattern will continue. When money starts to exit the equity market, the generals (investment banks) will re-evaluate. If projected earnings (real economic growth) are moving higher despite the tightening of credit, it doesn't matter. They will continue to invest their capital in companies causing the market to correlate with interest rates. This is the environment of a healthy market.
AlanN
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