Why the Fed Cut Sent Stocks Soaring

When rates go low, future profits go high. Everyone wants a cut

By Richard B. McKenzie. Excerpt:

"Profits in the future, dollar for dollar, are worth less than current dollars. This is because current profits can earn interest between now and the future, which means that future profits must be discounted by some percentage to make them equal to current profits. The further in the future profits are expected, the lower their current value.

Current market interest rates have long been a good proxy for the discount rate that should be applied to future profits to compute their present value to investors. It follows that a Fed rate cut can be expected to increase the present value of firms’ future profit streams—which can then be expected to increase firms’ current stock prices. Stock prices rise with Fed cuts because firms’ underlying future profit streams have become more valuable."