Warren Buffett called interest rates 'gravity' for asset prices. When rates change, every stock, bond, house, and currency on Earth is silently repriced. Here's the mechanism.
The risk-free alternative
Every investment competes with one boring alternative: lending to the government. If a government bond safely pays 1%, a risky stock only needs to promise a bit more to look attractive. If that same bond pays 5%, suddenly the stock has to promise a lot more — which, since its future profits haven't changed, means its price must fall. This is the single most important relationship in investing: when rates rise, the price of almost every asset feels downward pull.
The assets hit hardest are the ones whose profits live furthest in the future — fast-growing tech companies, for instance. A dollar of profit promised ten years from now is worth much less when you could earn 5% a year waiting. That is why rate-hiking cycles tend to bruise growth stocks the most, exactly what happened in 2022.
Housing: the most rate-sensitive market of all
Most people buy the monthly payment, not the house. At a 2% mortgage rate, a household that can pay $3,000 a month can borrow roughly $700,000; at 6%, the same $3,000 supports barely $460,000. When rates jump, buying power collapses — and eventually prices follow, as Canada saw vividly after 2022.
Canada's system transmits rate changes unusually fast: unlike US 30-year fixed mortgages, most Canadian mortgages renew every five years or less, so every hike works its way through household budgets within a few years. This is why the Bank of Canada watches household debt so nervously.
Currencies, jobs, and the feedback loop
Money chases yield across borders. When Canada's rates rise relative to America's, foreign money flows in to capture the difference, bidding up the loonie. A stronger loonie makes exports pricier and imports cheaper — which itself cools inflation. Everything is connected to everything.
The loop closes at the job market. Expensive money means fewer expansions, fewer expansions mean slower hiring, and slower hiring means weaker wage growth and spending — cooling inflation, which eventually lets rates fall and the cycle turn. A recession is what happens when this braking works too well.
Reading the news like an investor
This mechanism explains the market's strangest habit: cheering bad news. A weak jobs report can send stocks up, because weak hiring means cooling inflation, which means rate cuts sooner, which means less gravity on prices. Good news can do the opposite. Markets aren't reacting to the economy — they're reacting to what the economy implies about the price of money.
The takeaways
- Every asset competes with the risk-free government bond; when its yield rises, other prices fall.
- Long-duration assets (growth stocks) and leveraged ones (housing) feel rate moves the most.
- Canada's short mortgage terms transmit rate changes into households unusually fast.
- Markets often cheer weak data because it brings rate cuts closer.
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