How Does the Stock Market Respond to Interest Rate Increases?

March 28, 2022
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The Federal Reserve raised the Fed Funds rate a bit over a week ago for the first time since 2018. It now clocks in at a whopping 0.25-0.50%. Furthermore, they made it sound like they will get close to 2% by year end.1

Historically, a rate of 2% is teeny tiny. Just take a look at the chart of the effective funds rate going back to the 1950s. Hardly a blip. Taking us back to 2019 levels.

Regardless, it does beg the question, how does the stock market respond to rate increases? According to Reuters, Truist Advisory Services research showed that the S&P 500 averaged an annualized return of over 9% during 12 rate hike cycles since the 1950s.2 A recent Bloomberg writer, leaning on LPL Financial’s research, said “in the previous eight hiking cycles the S&P 500 was higher a year after the first [rate] increase every single time.”3

Of course, this doesn’t always happen. The high inflation of the 1970s was particularly rough for the stock market. It should be noted that they were increasing rates from a much higher base rate during that period. Unfortunately, though, inflation now is also high, but not near (yet? —hope not!) the 14% it reached in 1980.4 The relationship between stocks and rates increasing can be, as one JP Morgan writer put it, “murky”.5

Another point worth mentioning is that just because the Federal Reserve has indicated that they plan to continue raising rates for quite a while doesn’t mean they will. A few weeks ago, there were rumors of a potential 50bps jump instead of a 25bs jump at the March Fed meeting and that possibility got shot down quickly likely due to the horrific war in Ukraine. External events can change things quickly. The last several years have made that reality that much more obvious.

For now though, it seems that rates are going higher; however, we probably shouldn’t expect our savings accounts to become a money tree any time soon, especially with that cash-eating cookie monster called inflation out there.

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Sources:

1. https://www.wsj.com/articles/fed-raises-interest-rates-for-first-time-since-2018-11647453603

2. https://www.reuters.com/business/history-shows-stocks-can-weather-rate-hike-cycle-2022-03-16/

3. https://www.bloomberg.com/news/articles/2022-03-13/what-happens-to-stocks-when-the-fed-hikes-a-historical-guide

4. https://www.federalreservehistory.org/essays/great-inflation

5. https://www.chase.com/personal/investments/learning-and-insights/article/what-the-fed-raising-interest-rates-means-for-investors