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What Happens After A Rate Hike?

In honor of the imminent Fed rate hike this week, I wanted to know how the market has reacted historically to the Fed raising interest rates.  For the market data, I pulled the weekly data going back to mid-1990 for the S&P 500 from Yahoo Finance.  For the Fed rate changes, I used the website fedprimerate.com

Outside of December of last year, you have to go back to 2006 to find a period of tightening monetary policy. Since July of 1990, the fed has raised rates a total of 34 times, 32 of which were 25 basis point hikes and 2 were 50 basis point hikes.  This makes it extremely difficult to compare this rate hike to others, as others have come mainly during times of great economic prosperity and economic expansion.  Outside of December of 2015, we have never seen what a rate hike will do to the stock market after ten years of zero interest rate policy.  After last year, we saw the Dow hit 15,503 in February, while the S&P dropped to 1810.1 and the NASDAQ down to 4,209.8.  This represented the first 10%+ correction we had seen during the current bull market, and while it was a far drop, it also recovered very quickly.  By this past summer, everything had sorted itself out, or at least we thought it had until the Brexit vote happened.

The average change in the S&P 500 during the actual week of those rate hikes was a gain of 0.80%, while the median change in the S&P was 0.58%.  However, if you look at the 5 week period following those rate hikes, the average decline is -0.21%, while the median decline is -0.31%.  Remember, most of these rate hikes happened during the periods between June of 2004 to May of 2006 (the housing boom), June of 1999 to May of 2000 (the dot-com bubble), and January of 1994 to January of 1996 (the middle of the longest period of economic expansion in US history).  The worst week, statistically, is the fourth week after a rate hike, in which the average weekly drop in the S&P is -0.57%.  Last year after the rate hike, we saw a 5.7% drop in the S&P500 in week 4, which follows this trend. 

I also looked at how many of those weeks during a rate hike fell into the top or bottom 10% of all weeks in terms of percentage change.  While the 5 weeks after the 2015 rate hike were not good (the market dropped 5.14%), they were not the worst on record, either.  In June of 2004, the market dropped 5.46% following a rate hike, and in June of 1999 the market dropped 6.54% in the five weeks after a rate hike.  However, then news isn’t all bad.  Following the August 2004 rate hike, the market rose 5.99%.  Of course, that only made up about half of what it had fallen after the June rate hike!  The last rate hike we saw prior to 2015 was in May of 2006, and the following 5 weeks saw the market decrease 3.07%.

Looking at a chart of the federal funds rate over time, there has never been a time in our history that we have seen such a long period of zero-interest rate policy.  Nor have we seen a time when the stock market has been on an incredible bull market run during a period of such economic stagnation.  The two things are definitely related, and the only question that remains is will the market hold up when the Fed really starts to tighten?