In light of the US Federal Reserve’s recent guidance that a rate hike could be on the not-so-distant horizon, many investors are concerned about the potential impact on US markets. History reveals there is no hard-and-fast rule for how markets react to rate hikes. In prior instances, markets have responded in a number of different ways when the Fed has raised rates.
12-month change in FTSE USA Index between July 1999 (when tightening began) and July 2000: 3.86%
Source: FTSE as of July 1, 2000. Past performance is no guarantee of future results.
At its June 30, 1999 meeting, the Fed raised the federal funds rate by a quarter percentage point, drawing little reaction from US markets. This was the beginning of a tightening aimed at curbing inflation. During this period, the Fed raised rates six times. At the end of 2000, markets rallied on favorable unemployment figures, and during the same year there was significant investment in technology and telecom.
12-month change in FTSE USA Index between June 2004 (when tightening began) and June 2005: 8.92%
Source: FTSE as of June 1, 2004. Past performance is no guarantee of future results.
Stocks were sold off immediately after the Fed announced on June 30, 2004 that it would raise the fed funds rate by a quarter percentage point to 1.25%. The decision was sparked by worries of a housing bubble but after only a few months of weakness stocks resumed their ascent. During the year, the Fed raised rates eight times, by a quarter of a percentage point each time. The Fed continued to raise rates all the way through the end of Fed Chairman Alan Greenspan’s term in July 2006.
These two snapshots illustrate that historically US markets haven’t reacted uniformly to rate hikes, as markets were influenced by other economic factors during these time periods. However, in both instances there was no evidence of a long-term decline, which could indicate that the Fed’s candor with investors – before and after the rate hikes – helped to manage expectations and restore confidence.
If the Fed announces a rate hike, a unique set of factors in today’s economic environment should influence the market’s reaction. The outcome for the market is also likely to be shaped by the extent to which the markets have already factored in the Fed’s guidance that rates will rise.
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