What's going on?

The last few weeks have been rife with talk of central banks taking action to increase interest rates. But the head of the US Federal Reserve (�the Fed�) poured some cold water on that enthusiasm on Wednesday, and markets reacted by sending stocks and bonds higher.

What does this mean?

In testimony to Congress on Wednesday, the chair of the Fed didn�t sound as supportive of higher interest rates as investors were anticipating. Specifically, she made some comments concerning the persistently low rate of inflation (previously, she had indicated that inflation would likely resume its rise shortly). Since central banks are typically loathe to raise interest rates when inflation is low (click here for more background), her comments were taken to mean that the Fed would proceed cautiously. She also essentially said that, under the current conditions, she doesn�t expect the Fed to raise interest rates much higher.

Why should I care?

For markets: Stocks and bonds recovered some of their recent losses.

Higher interest rates are almost always bad for bonds and sometimes bad for stocks. For bonds, investors would rather own them in the future if they pay more interest then, and hence they sell bonds today. The impact of rising interest rates on stocks is more complicated but, in short, it�s tougher for companies to make a profit if people and businesses are paying banks higher interest, rather than spending their money. As such, after the comments on Wednesday, stocks and bonds erased some of their losses from the past few weeks.


The bigger picture: Other countries may still take action to push up interest rates.

Investors� focus in recent weeks has been largely on central banks outside the US, particularly the European Central Bank (ECB) which is still engaging in extreme practices to keep interest rates low. Meanwhile, on Wednesday, the Bank of Canada increased its target interest rate for the first time in seven years. The Fed has increased interest rates much more quickly than most other developed countries; it may want other countries to catch up a bit before it aggressively ploughs ahead.