Fed Rate Increases Are Good For Markets - InvestingChannel

Fed Rate Increases Are Good For Markets

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What to Expect From the Fed This Week

On Tuesday, the Fed begins its monthly open committee meeting with rate announcements on Wednesday.

No one expects them to raise rates this month. However, markets are certain the Fed will begin in March.

Initially, forecasters penciled in two rate hikes for 2022. Now, those same pundits are calling for four.

The Fed will provide clarity on Wednesday to some degree. But whether we go with three or four or twelve isn’t the issue.

Timing is more important.

Fed members make their decisions based on data, which recently hasn’t been too good.

Don’t pay attention to the market reaction after the announcement. 

Instead, read what the committee writes as well as Chairman Jerome Powell’s testimony. Look for clues into how many hikes they expect this year and the data they’ll be using to make those decisions.

Interest Rates

Fed Rate Increases Are Good For Market

Key Takeaways

  • Markets rarely turn lower in the months following the start of a Fed rate hike cycle.
  • However, there’s little data on what happens leading up to the Fed rate hike.
  • Today’s inflationary pressures are similar to those faced in the late ‘70s and early ‘80s when the Fed led by Paul Volker hiked rates +15% sending the U.S. economy into a brief recession.
  • We could see something similar this time around since consumers hold so much cash.

Everyone expects Fed rate hikes to kill the market rally.

But history says this isn’t usually the case.

Returns After Fed Hikes

Fed rate hikes don’t happen too often. 

In the last 30 years, we’ve only seen it four times. And the S&P 500 held up just fine.

If you go back in history, markets rarely turn lower under rate increase cycles.

Our closest approximation would be the period from 1977-1984. During that time, OPEC’s limited supply of oil drove inflation through the roof.

Paul Volker jacked up rates to +15% to ‘break the back’ of inflation.

And it worked. Yes, it drove the U.S. into a temporary recession for six months in 1980. But we quickly exited.

During that 7 year time period, the S&P 500 gained more than 60%.

Why is This Time Different?

To start with, we haven’t entered the rate hike cycle yet. And there isn’t a lot of studies on what happens leading up to a rate hike cycle mainly because the Fed didn’t know it would hike rates until it did.

That makes our current situation unique.

Inflation broadened this time around, impacting more areas of our lives. We pay more for everything from gas to food to housing.

Consumers also carry a lot of cash.

The chart below shows household assets, liabilities, and net worth as a percentage of disposable personal income.

As you can see, household assets and net worth are at some of the highest levels in recent history while debt remains in check.

Federal government stimulus added to personal wealth along with wage hikes, though they failed to keep pace with inflation.

Still, that means consumers won’t be hurt by higher interest rates until they burn through their cash.

That could force the Fed to send rates much higher than markets priced in.

The Bottom Line: Leading into the Fed rate hikes, likely to hit in March, and even through Q2, we can see growth stocks tumble as markets attempt to price in the correct number of rate hikes.

That makes high-growth names in the Nasdaq 100 less appealing and those in value ETFs such as the Invesco S&P 500 Revenue ETF (RWL), iShares MSCI USA Value Factor ETF (VLUE), and Vanguard Russell 1000 Value Index Fund ETF (VONV) more valuable for the moment.

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