Fed increases discount rate, and what does this mean?

Market players are panicking at Wall Street as clients want out of stocks fearing the market will plunge.

I think there is going to be an overreaction to the news.

What does this news mean? Market players believe that this means the interest rate is going to be increased in the near future, nearer than expected. It could happen in September. While most people have been predicting Fed will only do this by December.

What does this do to stocks? Interest rate goes up, portfolio managers have to readjust their portfolio weightage. Perhaps they have to move some money out of stocks and change them to riskless assets like Treasuries which may give higher interest rates. They lower the risk for their clients and yield the same expected returns. (read on portfolio theory)

However, this is assuming that the returns are going to be bad for stocks. The interest rate is still 0-0.25% as of now, why are investors running away so early? The market is not ideal, some investors are just irrational. Perhaps they would like to run to other markets instead of US as the returns are now higher in another market.

It boils down to returns on stocks. Interest rate increase affects portfolio decision. Since we know what the portfolio manager might do – sell stocks, buy other investment vehicle, that is why traders start lowering the market value. And when that happens, the returns on stocks are now the same as the new portfolio. And everyone is happy.

Note that this would only happen once the interest rate changes. Not when we are speculating when it would change. I think any dip caused by this news is a buying opportunity.