The Effect of Lower Interest Rates on Asset Prices

Lower interest rates lead to higher earnings yield for stocks, resulting in a lower price-to-earnings ratio and increased asset prices. In the scenario described, a decrease in required earnings yield from 6.5% to 4.5% leads to a 44% increase in the price of assets. This relationship between interest rates and asset prices is a key factor in understanding the impact of lower rates on both stocks and bonds. Additionally, as company earnings typically grow while bond coupons remain stable, the required return on stocks may decrease further, potentially leading to even higher price-to-earnings ratios. Furthermore, the Federal Reserve can influence yields by purchasing bonds, further affecting asset prices.