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For professional and individual investors, executives or business students--a unique atlas of what makes the markets move. Developed from a popular in-house pamphlet used at Shearson Lehman, this accessible and thoroughly illustrated resource makes understanding economic indicators much simpler. Charts and ...
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For professional and individual investors, executives or business students--a unique atlas of what makes the markets move. Developed from a popular in-house pamphlet used at Shearson Lehman, this accessible and thoroughly illustrated resource makes understanding economic indicators much simpler. Charts and graphs.
Whether you are an investor, broker, financial market economist, business student, or speculator, want to know the future course of the you economy and inflation, the likely response of the Federal Reserve Bank to these developments, and, finally, the implications for interest rates. Why are we all so interested? Simply because the combination of these factors is going to largely determine the direction of the major financial markets.
This book is a simple, easy-to-use pictorial guide to the economic indicators and the Federal Reserve — the primary factors that move the markets. It describes how these key indicators work and what effect they have, and takes a detailed look at the U.S. central bank. Using this book as a guide, you will be better able to interpret the reactions of financial markets to economic news and plan accordingly.
Our first look is at the fixed-income markets. These markets are inexorably linked to interest rates because of the inverse relationship that exists between interest rates and the price of a security. When interest rates rise, the price of a bond falls and vice versa. For example, suppose an investor holds a Treasury bond that yields 8.0%. If the economy expands rapidly, inflation will eventually begin to climb — pushing bond yields higher to, say, 10.0%. In that case, the 8.0% bond will become less attractive and its price will decline; investors would rather own the new higher yielding 10.0% security. Thus, any market force that causes the economy to grow more rapidly, orcauses the inflation rate to rise, increases the likelihood that the Federal Reserve will raise interest rates and decrease prices in the fixed-income markets. Similarly, the process works just as well in reverse. Any market force that causes economic activity to decline, or the inflation rate to drop, increases the likelihood that the Federal Reserve will lower interest rates and raise prices in the fixed-income markets. Since the prices of fixed-income securities are so closely linked to interest rates, it is crucial for participants in this market to be cognizant of developments in the economy, the pace of inflation, and implications for Federal Reserve policy.
Movements in the equity (or stock) market are directly linked to the outlook for corporate profits. If profits are expected to rise, then stock prices will also rise. When times are good and corporate profits are rising, the stock market also rises. But, when bad times hit and corporate profits drop (such as in the recessions of 1973-74 and, again, in 1980-82), the stock market also falls. This relationship seems very sensible if you think about what determines corporate profits. Quite clearly the pace of economic activity plays a major role. If the economy dips into recession, corporate profits are certain to slide clearly a negative event for the stock market. Inflation also plays a role. To the extent that inflation rises, the real value of earnings and dividends declines — usually prompting stock prices to fall. Thus, a pickup in inflation is also viewed negatively by the equity markets. And if interest rates rise, the increased cost of borrowing by corporations reduces earnings. There is no question that other factors can play a role in establishing stock prices. At the micro level, management changes, technological developments, and the implementation of more sophisticated cost control procedures are important in determining the price of an individual company's stock. And, if the company is large enough, it can influence tile overall level of stock prices. Nevertheless, it is clear that the economy, inflation, and interest rates are critical factors in determining the future path of the stock market because of their correlation with profits. Thus, if you can come to terms with the macroeconomic environment, you are well on your way to becoming a better stock market investor.
Similarly, the foreign exchange markets are influenced by what is happening to the U.S. economy, inflation, and interest rates. Interest rates and the value of the dollar are linked. Specifically, the chart compares the difference, or spread, between interest rate levels on 10-year government bonds in the United States and Germany to the exchange rate between the dollar and the German deutschmark. As the spread widens — that is, as the interest rate levels in the United States are rising relative to rates overseas — the dollar rises, The reason for this relationship is that interestrate differentials are important ingredients in determining where investors are going to place their funds. If interest rates in the United States rise relative to foreign rates, dollar investments become more attractive. This heightened interest in U.S. securities means that foreign investors will need more dollars to make those purchases, hence the dollar tends to rise. Similarly, if U.S. interest rates decline in comparison with rates overseas, foreign securities are preferable and the value of the dollar declines. Of course, other factors can be important at times. For example, in 1985, U.S. policymakers decided that the greenback was overvalued and tried to actively push the value of the dollar lower via intervention in the foreign exchange markets. Events overseas can be important as well. The strength of the Japanese and German economies, their inflation rates, and the direction of their interest rates are equally important. But there is no question that the pace of economic activity in the United States, our inflation rate, and our interest rates greatly influence the value of the dollar.
No matter what market you are most closely associated with, it behooves you to have a working knowledge of what drives the economy, what produces inflation, and what factors are going to cause the Federal Reserve to change policy. Ultimately, you need to forecast the direction of interest rates.