@theMarket: Markets Cheer Fed Rate Hike

Yes, you read that right. For the first time in a long while, stocks celebrated what has historically been a reason to sell stocks the day after a rate hike. There are reasons why, and inflation is at the top of the list.

 

Historically, the S&P 500 Index has risen on only 35 percent of days when the Fed raises rates. The vote to raise rates was unanimous, with all 12 FOMC members voting to tighten. Fed Chair Kevin Warsh made it clear in his post-announcement remarks that he is not happy with the pace of the inflation fight.

 

The nation has been saddled with rising inflation for five years, and indications suggest the FOMC doesn't see inflation reaching its 2 percent target for another two years. Although he didn't say it, the market now believes this isn't a "one and done" hike. Most believe yesterday marked the start of a new interest rate hiking cycle.

 

The betting is that there will be at least two more hikes, if not more, in the months ahead. I looked back to find out how stocks behaved during similar cycles over the past 30 years. In the first several months, equities typically struggle for a few months before regaining their footing about 4 months later.

 

Two exceptions to this rule stand out. In 1997, the index gained 8 percent in the first two months as the dot-com boom began its climb. I see similar behavior today, thanks to the AI-driven environment. In March 2022, the opposite occurred, with the initial hike precipitating a negative period of more than 12 months and a 25 percent decline.

 

If I pull back and look at performance over the last century, the S&P 500 Index has risen during nearly every Fed rate-hike cycle, in eight of the last nine major tightening periods between 1971 and 2022.

 

If you have been reading my recent columns on the bond market, you know two issues were on the table going into this meeting. Would Trump-appointed Kevin Warsh bow to his boss and refuse to raise interest rates, casting the Fed's independence into doubt? And would a Fed interest rate hike further exacerbate climbing bond yields on the long end of the curve?

 

We now know the answer — no. It appears the president reconciled himself to his appointee's action because of a "very tough board," even though he insists U.S. interest rates should be 1 percent or less, according to his social media posts. That goes a long way to putting to bed the independence narrative.

 

As for yields, the benchmark 10-year Treasury bond yield fell from 5.01 to 4. 95 a day later. Whether that was due to a decline in oil prices or a little more confidence that the Fed was "doing something" about inflation remains to be seen. One day does not make a trend, but at least bond yields didn't go up (although by Friday the 10- year was back to 5 percent).

 

If there was ever a time to raise rates without risking negative repercussions to the jobs market and the economy, it is now. Both areas have proved strikingly resilient this year in Warsh's estimation. "Geopolitical developments," which is Warsh speak for the Iran War, have fueled a re-acceleration in inflation. This is driven by higher energy prices filtering through a broad range of consumer goods and services across the economy.

 

Given that inflation data will continue to accelerate through the next two months, I can see the narrative build among market participants that even more interest rate hikes will be necessary to quell inflation. That would be a mistake. It could result in the Fed tightening rates at a time when the economy begins to slow, thanks to a re-rating of the AI trade and the end of the administration's efforts to grow the economy before the midterm elections.

 

This week, the Fed's hike saved the stock market. Friday was a triple witching day when $7 trillion of options expire. I would discount any moves up or down in the market as a result since it is purely a bookkeeping event in the financial markets. Markets are balanced on a knife edge and next week could go either way depending on the path of oil prices, bond yields, and the Trump/XI summit.