Rate hikes aren’t necessarily bad for stocks

The stock market is hovering around all-time highs despite the Federal Reserve (Fed) preparing to raise rates. Will stocks fall once a tightening cycle begins?

Market participants were spooked yesterday by news that inflation in December rose 7% year-on-year. The rate is well above the Fed’s definition of price stability and calls for central bank intervention.

Through intervention, the market expects a tightening cycle to begin in March. In addition, multiple rate hikes are expected this year. Will this new tightening cycle penalize equity performance?

If history tells us anything, it won’t.

Stocks outperform after first rate hike

Stocks tend to outperform during a cycle of monetary easing. So when the central bank lowers rates or eases through unconventional monetary policies, such as quantitative easing, stocks rally.

But rate hikes aren’t necessarily bad for stocks.

When a new tightening cycle begins or the Fed makes the first rate hike, history tells us that the S&P 500 will outperform over the next three, six and twelve months. On average, the index delivered +2.7%, +7.5%, +10.8% respectively after the first rate hike of a tightening cycle.

Take the last tightening cycle, which began in December 2015. In the first three months after the first rally, stocks lost -1.1%. However, after a year, stocks are up +9.1%. Therefore, rate hikes are not always bad for stocks, as many might think.

Why is the Fed not increasing in January?

This is not possible.

The Fed is still buying assets as part of its quantitative easing program. Raising rates while easing policy makes no sense. Also, it will have no effect.

Because the Fed announced that the reduction in asset purchases would end before its first rate hike, March is the first meeting where it can propose a rate hike.

Can the Fed appear hawkish at its January meeting? Yes, it is possible – by announcing a faster tapering, which puts into question the prospects of a rate hike of more than 25 basis points.

All in all, the Fed must act to maintain its credibility. For example, for a long time during the pandemic, he called for transitional inflation — until he dropped the word transitional from his statements. To avoid making the same mistake, the Fed could offer more hikes this year than the market expects.

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