What is the Fed and how do interest rates affect stocks?
Nov 3, 2026
The Federal Reserve, often called the Fed, is the central bank of the United States. Its decisions on interest rates are followed by investors around the world, because they can affect borrowing costs, the value of the US dollar and the prices of shares and bonds. This guide explains what the Fed does, how it sets interest rates and the main ways rate decisions can affect the stock market.
What the Fed is
The Federal Reserve System was created by the US Congress in 1913. It has three main parts:
- the Board of Governors in Washington, D.C., which has seven members appointed by the US President and confirmed by the Senate
- twelve regional Federal Reserve Banks, such as the Federal Reserve Bank of New York
- the Federal Open Market Committee (FOMC), which sets monetary policy
The Fed is independent within the US government. Its decisions do not need to be approved by the President or Congress, although the Fed reports to Congress regularly.
What the Fed is trying to achieve
Congress has given the Fed a dual mandate: maximum employment and stable prices. The Fed defines stable prices as inflation of 2% over the longer run, measured by the personal consumption expenditures (PCE) price index. When inflation is above this goal, the Fed may raise interest rates. When the economy weakens and unemployment rises, it may lower them.
Who makes the decisions
Interest rate decisions are made by the FOMC. It has twelve voting members: the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York and four of the other eleven regional bank presidents, who vote on a rotating basis. The FOMC usually meets eight times a year. After each meeting it publishes a statement, and the Fed Chair holds a press conference. At four of these meetings, the committee also publishes economic projections, including its members' views on future interest rates.
The federal funds rate
The main tool the Fed uses is the federal funds rate, the interest rate at which banks lend money to each other overnight. The FOMC sets a target range for this rate, for example 3.75% to 4%. To keep the rate within that range, the Fed uses other tools, such as the interest rate it pays banks on the money they keep at the Fed (interest on reserve balances) and overnight reverse repurchase agreements.
Changes in the federal funds rate can feed through to other interest rates in the economy, such as rates on mortgages, car loans, credit cards, company loans and savings accounts.
Other tools: the Fed's balance sheet
The Fed can also buy or sell large amounts of government bonds and other securities. Buying bonds, sometimes called quantitative easing, can push longer-term interest rates down. Reducing the Fed's bond holdings, sometimes called quantitative tightening, can have the opposite effect.
How interest rates can affect stocks
There is no fixed rule for how share prices react to a Fed decision, but there are several common links:
- Borrowing costs: higher interest rates make it more expensive for companies and households to borrow. This can slow spending and investment, and may affect company sales and profits.
- Valuations: investors often value a company by estimating its future profits and discounting them back to today. When interest rates are higher, future profits are worth less in today's money, which can weigh on share valuations, especially for companies whose profits are expected further in the future.
- Competition from bonds and savings: when rates rise, bonds and savings accounts can offer higher returns. Some investors may move money from shares to these assets, and the reverse can happen when rates fall.
- The US dollar: higher US interest rates can make the dollar stronger. A stronger dollar can reduce the value of overseas sales for US companies when they are converted back into dollars.
Why sectors can react differently
Interest rate changes do not affect all companies in the same way. Banks may earn more on loans when rates rise, but they can also face higher funding costs and more loan defaults if the economy slows. Utilities and real estate companies often carry a lot of debt, so their borrowing costs are closely linked to rates. Growth companies, such as many technology firms, are often more sensitive to changes in valuations.
Expectations matter
Markets often move before the Fed acts, because investors try to anticipate decisions. As a result, the reaction to a decision can depend on whether it was expected. The wording of the Fed's statement, the projections and the Chair's comments at the press conference can matter as much as the decision itself.
Where rates stand now
At its meeting on October 28, 2026, the FOMC kept the target range for the federal funds rate at 3.75% to 4%, after raising it by 0.25 percentage point in September. The next scheduled meeting is on December 8–9, 2026, and includes new economic projections.
What this means for investors
For Investing.one users following US markets, including S&P 500 ETFs such as CSPX.ETF and VUSA.ETF, Fed decisions and statements may be relevant. Interest rates are one of many factors that can affect markets, alongside company results, economic data and global events.
Sources
- Federal Reserve: About the Fed
- Federal Reserve: Federal Open Market Committee
- Federal Reserve: Policy tools
- FOMC statement, October 28, 2026
- FOMC meeting calendar
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