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SCOTT JAGOW: The Dow lost several hundred points last week and the major reason was new signs of inflation. Signs of inflation likely mean more interest rate hikes. The Fed's already raised short-term rates 16 times in a row. Newsweek's Allan Sloan joins us now. Hi Allan.
ALLAN SLOAN: Hey Scott
SCOTT JAGOW: Why exactly are higher interest rates such a wet blanket on the stock market?
ALLAN SLOAN: The theory is that high interest rates are bad for stock prices for two reasons. One is that they make bonds and money market funds and things like that more attractive relative to stocks than they are when rates are low. The second thing involves a piece of economic theory, which is, if you look at a dollar of profits somewhere in the future and you try to figure out what it's worth today, the higher interest rates are, the lower today's value of a dollar of earnings.
SCOTT JAGOW: Obviously when you look at the economy overall one of the major areas where higher interest rates have such an impact is housing.
ALLAN SLOAN: Clearly, it's going to be a drag because the whole game in the housing market is 'what's my monthly payment?' If your monthly payment is higher, you can afford less house. Logic would suggest that if you're paying more on your mortgage you're spending less on other things, especially since rising interest rates generally hurt the value of housing and hurt the ability to borrow out your equity which has kept the economy afloat. So higher interest rates are going to hurt the economy by slowing down the spending of people who are taking money out of their houses.
SCOTT JAGOW: There have to be some beneficial effects of having higher interest rates, right? What are they?
ALLAN SLOAN: Sure, well there's one beneficial effect for me, which is money market yields have really gone up. About a year ago, the average money market fund was returning something like one half of one percent, you know which is not a lot of money, and now it's retuning something like four. The second thing is, if you think that the value of the dollar matters, which I happen to think, higher interest rates on dollar investments make the dollar stronger relative to other currencies than it would otherwise be.
SCOTT JAGOW: So last week we talked about how great the Dow was doing and then in the next few days it lost several hundred points, so do we need to print a retraction on the radio?
ALLAN SLOAN: Last week I violated one of my prime commandments, which is never talk about stock prices because it's easy to be wrong and it's easy to look like an idiot.
SCOTT JAGOW: No jinxes. Alright Allan thanks.
ALLAN SLOAN: My pleasure Scott.
SCOTT JAGOW: Allan Sloan is the Wall Street editor for Newsweek Magazine. He'll be back next week with another edition of the Sloan Sessions.