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Will the Federal Reserve raise rates as expected this week? Wall Street is debating: will it end the U.S. stock bull market?
After an unexpectedly strong U.S. CPI report came out last Friday, traders generally expect the Federal Reserve to begin raising rates at this week’s policy meeting—marking the first rate hike in more than three years.
Historically, previous rounds of rate hikes have offered a reference point for today’s market. Based on past experience (though history of course can’t guarantee the future), U.S. stocks may first weaken, then rebound.
Among the six tightening cycles since 1994, during the first four months after the rate-hike cycle began, the S&P 500’s average return was negative.
This suggests that once the “rate-hike shoe” drops, U.S. stocks may look lackluster through the beginning of next year.
As of the close last Friday, the benchmark U.S. equity index, the S&P 500, is up nearly 12% year to date. Strong corporate earnings and a fairly resilient economy have provided solid support for bulls in the stock market.
If you extend the time horizon, the S&P 500’s performance tends to improve gradually: in the 12 months after the start of a rate-hiking cycle, the index’s average return is close to 7%, with a median return of about 11%. (Using median-based statistics helps remove distortions from extreme outliers—for example, the index surged more than 40% after hikes began in March 1997.)
If the Federal Reserve implements a rate hike this Wednesday, it will be the first hike since July 2023—when the Fed raised rates to a range of 5.25% to 5.50%.
Currently, the federal funds rate in the U.S. is at 3.50% to 3.75%. According to the CME Group’s FedWatch tool, futures traders currently assign an 86% probability to a 25-basis-point hike this week.
One positive factor for the market is that mega-scale cloud service providers are still driving growth in excess returns through large-scale AI spending. The S&P 500 component stocks’ forecast for earnings growth in 2027 is expected to reach double digits. If the outlook for AI spending remains unchanged, it may be enough to offset any cooling in optimistic sentiment caused by the rate hikes.
Another bright spot for equities is that although inflation remains sticky, it appears to be slowing. The inflation rate has fallen from a May peak of 4.2%. This should allow the Federal Reserve to take a more gradual approach, and the data shows that the pace of rate hikes is crucial for stock performance—slower pacing gives investors more time to absorb policy changes! $BZ
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