This website uses cookies to collect usage information in order to offer a better browsing experience. By browsing this site or by clicking on the "ACCEPT COOKIES" button you accept our Cookie Policy.

How Does the Stock Market React to Rate Hikes by The Fed?

Seasonax

Contributor:
Seasonax
Visit: Seasonax

By:

Cofounder of Seasonax

Eight times a year the world is holding its breath waiting for the announcements of the Federal Open Market Committee (FOMC).

The Fed has a dual mandate: to maximize employment and to keep prices stable. It does that by setting the target for the most important interest rate that affects the entire US economy including the US stock market – the Federal Funds Rate (the rate at which banks lend to each other overnight).

This rate is tightly linked to inflation. Countless inflation headlines have drawn our attention in recent months. But how does inflation actually work? To keep it simple: when interest rates are kept low, borrowing appears more attractive to households and corporations, which will stimulate additional growth.

Consumers will spend more and businesses will be able to finance their operations and pay for expansions. As a result, their future prospects improve, making their stocks more attractive. Greater availability of credit leads to more buying/spending and with a lag to surging inflation. This in turn gives rise to rate hikes, leading to a reversal of the process described above.

Stock Market Reaction to Rate Hikes

The last hike in the Federal Funds Rate was implemented on December 20, 2018. Back then, the world looked different, GDP growth was 2.07%, the unemployment rate stood at 4.7%, CPI inflation was 2.05% and the Federal Funds Rate was set at a range of 2.25 – 2.5%.

The Fed made its famous promise not to take any further steps regarding rate hikes. And they have kept it until today! (Since then, some traders jokingly refer to Fed chair Jerome Powell as J. “Pivot” Powell).

On March 15 2020, the Federal Funds Rate was cut to a range of 0% to 0.25% and has been held there ever since. During the pandemic cutting rates appeared to be a sensible measure, but what will happen when the global economy completely reopens again, and inflation fears persist?

By looking at the past performance of the S&P 500 Index we can draw some conclusions and prepare for the future.

The chart below shows the average performance of the S&P 500 Index over the 62 trading days before and after rate hikes by the Fed. The chart was calculated over the past 30 years, during which 40 rate hikes have been implemented. The horizontal scale shows the number of days before and after the Fed announced a rate hike, the vertical scale the average move of the index in percentage points. The vertical orange line marks the day of the rate hike.

Performance of the S&P 500 Index 62 days before and after a rate hike in the past 30 years

Performance of the S&P 500 Index 62 days before and after a rate hike in the past 30 years

Source: Seasonax

On the seasonal chart it can be clearly seen that the S&P 500 Index enters a downtrend immediately after the rate hike announcement.

However, not very long after the rate hike, prices begin to increase again. To be precise, 18 days after the rate hike the index begins to generate positive returns – in exactly 77.5% of the past 40 events in the period under review. Statistically speaking the S&P 500 Index posts a strong average gain of 2.51% between the 18th and the 61st day following a rate hike.

Pattern returns of the S&P 500 Index for every year since 1994 in which a rate hike was implemented

Pattern returns of the S&P 500 Index for every year since 1994 in which a rate hike was implemented

Source: Seasonax

Fast forward

The annualized US inflation rate accelerated to 5% in May 2021. This represents the highest reading since August 2008. According to Trading Economics the biggest price increases were recorded in gasoline (56.2%), used cars and trucks (29.7%), utility gas service (13.5%), transportation services (11.2%), apparel (5.6%) and food (2.2%).

How the Fed will deal with the rising prices and inflation in the future remains an open question for the time being. However, one thing is certain: the market will definitely react.

Addendum: it should be noted that seasonality measured from 1994 (as in our example) refers to a disinflationary era, this is to say, inflation was in an overarching secular downtrend during this time. As long as that remains the case, seasonality charts (indirectly) related to inflation and referring to this time period will remain valid. However, if the secular inflation trend reverses as it did in the 60s and 70s, this may well change. Experience shows inter alia that stock market valuations will contract significantly (P/E ratios will plummet).

Apart from events such as the Fed meeting, seasonality analysis shows that there exist countless recurring patterns in all kinds of different markets. From stocks to indexes, commodities, currencies and even bonds, every market has something to offer.
To make finding these opportunities even easier, we have launched a Seasonality Screener. The screener is an analytical tool designed to identify trading opportunities with above-average profit potential starting from a specific date. The algorithms behind the screener are based on seasonal patterns that recur almost every calendar year.

Feel free to analyze more than 20.000+ instruments including stocks, (crypto)currencies, commodities, indexes by signing up to a free 3-day trial.

Originally Posted on July 14, 2021 – How Does the Stock Market React to Rate Hikes by The Fed?

Disclosure: Seasonax

Past results and past seasonal patterns are no indication of future performance, in particular, future market trends. Seasonax GmbH neither recommends nor approves of any particular financial instrument, group of securities, segment of industry, analysis interval or any particular idea, approach, strategy or attitude nor provides consulting nor brokerage nor asset management services. Seasonax GmbH hereby excludes any explicit or implied trading recommendation, in particular, any promise, implication or guarantee that profits are earned and losses excluded, provided, however, that in case of doubt, these terms shall be interpreted in abroad sense. Any information provided by Seasonax GmbH or on this website or any other kind of data media shall not be construed as any kind of guarantee, warranty or representation, in particular as set forth in a prospectus. Any user is solely responsible for the results or the trading strategy that is created, developed or applied. Indicators, trading strategies and functions provided by seasonax GmbH or on this website or any other kind of data media may contain logical or other errors leading to unexpected results, faulty trading signals and/or substantial losses. Seasonax GmbH neither warrants nor guarantees the accuracy, completeness, quality, adequacy or content of the information provided by it or on this website or any other kind of data media. Any user is obligated to comply with any applicable capital market rules of the applicable jurisdiction. All published content and images on this website or any other kind of data media are protected by copyright. Any duplication, processing, distribution or any form of utilisation beyond the scope of copyright law shall require the prior written consent of the author or authors in question. Futures and forex trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing ones’ financial security or lifestyle. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results. Testimonials appearing on this website may not be representative of other clients or customers and is not a guarantee of future performance or success.

Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from Seasonax and is being posted with permission from Seasonax. The views expressed in this material are solely those of the author and/or Seasonax and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.

Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.

Disclosure: Forex

There is a substantial risk of loss in foreign exchange trading. The settlement date of foreign exchange trades can vary due to time zone differences and bank holidays. When trading across foreign exchange markets, this may necessitate borrowing funds to settle foreign exchange trades. The interest rate on borrowed funds must be considered when computing the cost of trades across multiple markets.

Disclosure: Digital Assets

Trading in digital assets, including cryptocurrencies, is especially risky and is only for individuals with a high risk tolerance and the financial ability to sustain losses. Eligibility to trade in digital asset products may vary based on jurisdiction.

Disclosure: Futures Trading

Futures are not suitable for all investors. The amount you may lose may be greater than your initial investment. Before trading futures, please read the CFTC Risk Disclosure. A copy and additional information are available at ibkr.com.

trading top