The Federal Reserve is likely to raise its benchmark interest rate at next week’s meeting by 0.5%. We haven’t had a rate increase that high since the dot-com bust in 2000. If we did have a half-point rate hike, how would the stock market perform?
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The consumer price index rose 8.5% in March from a year ago, the biggest annual gain since December 1981. Rising inflation prompted the Federal Reserve to turn more hawkish. Treasury yields have jumped and the stock market, particularly the tech sector, has taken a beating. The 10-year Treasury note is nearing 3%, at a rate which it hasn’t hit since November 2018.
As of Thursday, the odds for a rate hike from 0.50% to 0.75% was 98.7%, compared with 1.3% for an increase of 0.25% to 0.50%, according to the CME Group’s FedWatch tool, which tracks interest rate futures. As of now, no one is betting the Fed would raise rates 0.75% or higher, despite some chatter of that possibility.
Market Performance Around Interest Rate Hikes
A study conducted by Dow Jones Market Data analyzed how markets reacted to the last five interest rate hikes of 0.50% or more, both before the hikes were announced and in the weeks and months that followed. The results are below.
| Average performance (%) around rate hike of 50 basis points or more | ||||||||||||
| Index | -1M | -3 Wk | -2 Wk | -1 Wk | +1 wk | +2 Wk | +3 Wk | +1M | +2M | +3M | +6M | +1 AND |
| dow jones | 0.70 | -0.52 | -1.21 | 0.67 | 0.02 | 0.39 | 1.38 | 1.94 | 3.30 | 4.58 | 9.60 | 22.48 |
| S&P 500 | 2.00 | 0.86 | -0.83 | 0.96 | -0.16 | 0.14 | 1.26 | 1.90 | 2.85 | 4.10 | 7.55 | 17.52 |
| Nasdaq Composite | 1.72 | 0.80 | -3.01 | -0.35 | -0.37 | -0.45 | 2.99 | 3.27 | 6.22 | 5.88 | 9.76 | 18.74 |
| Russell 2000 | 1.01 | 0.94 | -2.21 | -0.44 | -0.39 | -0.53 | 1.97 | 1.98 | 3.58 | 3.00 | 6.90 | 15.87 |
| Source: Dow Jones Market Data | ||||||||||||
Since June 1989, there have been a total of five rate hikes of 50 basis points or more. The most recent was in May 2000. Before that, there were three rate hikes of 0.5% in February 1995, August 1994 and May 1994. There was one 0.75% rate hike in November 1994.
As you can see, the markets reacted negatively to the rate hikes both two weeks before they were announced and two weeks after. But after the two-week period following the hikes, the stock market gained, in some cases sharply.
Market Correction Intensifies; What To Do Now
Have Markets Changed Since The Dot-Com Bust?
Granted, the economy and the markets have changed since 2000. Still, looking at how the markets reacted historically to those rate hikes may give investors a glimpse at how the markets might react this time.
“Over the past couple of months, we have seen rates increase at one of the fastest paces in decades. Thus, even as the economy has done well and earnings continue to grow, those higher interest rates have acted as a headwind,” said Brad McMillan, Chief Investment Officer for the Commonwealth Financial Network. “Markets already expect—and are pricing in—substantially higher rates. From here, any more damage has to come from interest rates moving even higher than the current substantial increases expected.”
In other words, investors may expect some downside and volatility both in the two weeks before the Fed’s May 3-4 meeting and in the wake of that announcement. After that, history says to look for the market to bounce as the economy and markets absorb higher interest rates.
Follow Michael Molinski on Twitter @IMmolinski
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