Investors have been watching the Federal Reserve like a hawk recently, and they've waited for this day for a long time. The central bank has telegraphed its intention to start raising interest rates, and with a decision due out this afternoon, only a surprise about-face prompted by the Russian invasion of Ukraine would stop the Fed from boosting its key short-term interest rate by at least a quarter of a percentage point. Rate hikes often prove challenging for stocks, but market participants seem just to want some clarity going forward. As of 11:30 a.m. ET, the Dow Jones Industrial Average (^DJI 0.69%) was up 385 points to 33,929. The S&P 500 (^GSPC 1.20%) rose 70 points to 4,333, while the Nasdaq Composite (^IXIC 1.59%) jumped 357 points to 13,306.
As you can see from the rise in the Nasdaq, beaten-down technology stocks saw a nice bounce from recent losses. However, a couple of stocks that largely fly under the radar also enjoyed solid gains. Below, we'll look more closely at Charles Schwab (SCHW 1.31%) and Interactive Brokers (IBKR 1.39%) to reveal why they're doing better and why a rising rate environment might actually be good for the brokerage companies.
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A big day for brokers
Shares of Schwab and Interactive Brokers were up almost in lockstep, rising between 5% and 6% on the day. Several factors combined to make investors more bullish about the two brokerage companies and their respective future prospects.
The most obvious boost to Schwab and Interactive Brokers came as a result of investors' renewed confidence in the stock market. Although trade commission revenue has dwindled in light of decisions from Schwab and other brokerage giants to charge no commissions on many stock trades, the brokerage companies still benefit from greater volume. The more investors are interested in the stock market, the better these businesses do -- and the threat of a long correction or bear market has weighed on sentiment recently.
However, there's also a more direct connection between the fortunes of Schwab and Interactive Brokers and what the Federal Reserve might do later today. When investors open brokerage accounts, they often leave substantial amounts of cash uninvested. Brokers can use that uninvested capital to make money, typically paying little or no interest on cash balances in brokerage accounts. When the Fed raises the Federal Funds rate, the amount brokers can make on that cash typically rises more than it pays to its customers.
In Schwab's case, moreover, money market mutual funds also play a key role. Schwab offers these investments as a way for investors to keep money in a cash-like instrument with full liquidity and minimal risk. However, Schwab has had to invest that money in securities that have paid very little interest, and as a result, the funds have had to waive some of their expenses just to keep their income yields to shareholders positive.
If interest rates rise, then money market mutual funds will be able to get more income from their investments. Some of that might go to investors, but the most immediate positive impact will be that Schwab and its peers will no longer have to offer these costly subsidies to their customers.
Keep your eyes on the Fed
In addition to the amount of any rate increase, the discussion of the Fed's rationale for its decision will be critically important. Investors want to have a better sense of what the future will bring with respect to monetary policy, so they can plan more effectively and adapt to changing economic conditions. For now, everyone seems hopeful that the central bank will once again manage to keep the economy on an even keel even through challenging times.
