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Stocks surged on Wednesday, with small caps leading the way after subdued June inflation data led investors to reverse their expectations for future rate hikes.
A rate hike from the Federal Reserve at its July FOMC meeting in two weeks is still all but certain. But investors are now calling July the top of the Fed’s benchmark rate this cycle, as market participants have assessed out a September rise considered likely only a few days ago.
The simplest reading of this market action is that an easier Fed is better for stocks. Consider this another coal on the fire fueling this summer’s bullish narrative for the market.
And if this is indeed the end of Fed rate hikes, history is on the bull side. At least for a little while.
Barclays data shows that in the year since the last rate hike of the last seven Fed rate hike cycles, the S&P 500 has, on average, gained 10%. A return in line with the historical average annual gain of the index.
The challenges for stock bulls, however, begin when the rate cuts begin.
On average, the benchmark has been flat in the year since the Fed’s first cut. And in 1981, 2001 and 2007, the index fell nearly 20% (or more) after the central bank’s first cut.
Of course, it’s usually not the cut itself that hurts the stock market, but rather Why the Fed cut that inflicts the pain. Typically, a weak or recessionary economy and a slowing labor market prompt the Fed to act.
Investors have learned well over the past decade that lower interest rates are better for risky assets, and using that logic, the Fed’s rate cut is good for stocks.
But with the Fed Powell predicting four rate cuts in 2024 and four more in 2025, stock bulls should be careful what they wish for. And why.
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