Here’s a quiz. Which doesn’t belong:
(a) COVID 19
(b) massive unemployment
(c) small businesses closed down
(d) stock market rising

The best answer in (d). It may seem crazy and counter-intuitive, but as of today, the stock market is sharply rising amidst the hardships from the virus. There are a several explanations, and one that cannot be overlooked is the “Zero Interest Rate Policy,” or ZIRP.

Does ZIRP mean that when you take out a mortgage or other loan, you pay zero interest, or that a bond you bought will return absolutely nothing? No, at least not now. ZIRP means that the “Fed Funds Rate” is at zero.

The Fed Funds Rate is the interest rate that banks charge each other for overnight loans, and it is set by the U.S Federal Reserve (the Fed). The purpose of these super short-term “bank-to-bank” loans is to add liquidity (money) into the economy.

The Fed Funds Rate acts as a basis for all other interest rates, from 30-day treasury notes and to 30-year mortgages. Reduce the Fed Funds Rate, and interest rates are supposed to drop on much of the longer-term debt throughout the economy. It’s like a domino or cascading effect.

Lowering interest rates is supposed to “stimulate” the economy, because it becomes cheaper to borrow, so you are more likely to take out a loan to buy a house or a car. Businesses can use low interest rate loans to expand, invest in themselves and hire people, at least in theory.

Perhaps the biggest reason why ZIRP makes stocks rise is because there’s nowhere else to go. You can’t make any money buying a US bond.: ten-year government bonds now pay you 0.68% per year. That’s almost nothing. Even high quality – “investment grade” — corporate bonds pay about 2.30%.

Many publicly traded companies pay annual dividend rates that significantly exceed these paltry bond rates. Plus, stocks can go way up (or down). Since you can’t make any money in bonds, buy stocks.

ZIRP, therefore, pushes investors out of bonds into the stock market. This makes stocks go up. It’s great for the people who own stocks. But those who can’t afford stocks – which is most people — do not directly benefit.