The Federal Reserve will be meeting on Tuesday, September 20th and Wednesday, September 21st to discuss the broader economy and consider raising interest rates for only the second time in over 10 years. Fed Fund futures rates imply roughly a 10% chance that committee will raise the key short-term rate by .25%.1 A more likely scenario is that the members will wait until December before the next rate hike.
In either scenario, short term interest rates will remain near historical lows for the time being. Over the coming months, we’ll be most interested to learn the pace of interest rate hikes, rather than the timing of any one incremental increase. When the Federal Reserve Open Market Committee begins raising interest rates to slow the economy and rein in inflation, this is known as monetary “tightening”. The pace of these tightening cycles can have important impacts on investment markets and the economy.
The chart below illustrates the performance of the S&P 500 under four monetary policy scenarios: The average of non-tightening cycles, all tightening cycles, slow tightening cycles and fast tightening cycles. As you can see from chart, there are typically significant and predictable differences in market performance between slower/longer rate hikes (green line) and more rapid increases in rate hikes (red line). The S&P tends to perform much better when the Fed favors a slower tightening schedule vs. needing to move quickly. If they do decide to raise next week, that will be nearly nine months between moves. Although these would make only two data points, it would set the stage for the more favorable slow cycle group. While we believe the likelihood of a rate hike next week is modest, we would expect market digest the news after perhaps an initial reaction.
Our advice to clients is to look past any market movement related to short term interest rate increases. Instead, consider the long-term reason why the Fed would be hiking rates: an improving economy. That should be good news for stocks in the long run.
1 Ned Davis chart B390, “Fed Funds Expectations”, 2016.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
