Do we really need to fear a rate hike?

in LeoFinance2 years ago

The end of the Federal Reserve's accommodative monetary policies is perhaps the most talked-about topic in the financial media, and it continues to act as a drag on any forward run in the stock markets.

According to Fed funds futures contracts, options traders are betting on two rate hikes in 2022 and expecting three more hikes in 2023.

In other words, most traders are predicting that low rate policies won't last much longer.

Now, I have often talked about this issue and I do not want to explain to the point of boredom my opinion that any increase in rates can only be a small demonstration act.

In fact, if the accommodative approach of central banks really changed, governments around the world would go bankrupt in a week, overwhelmed by unsustainable interest expenses.

This time, however, I want to take the problem from another angle.

Let's assume that the Fed really starts to do some timid rate hike and let's focus on the short to medium term...

How would the stock markets react?

Can you predict the reaction of investors based on the reactions that occurred the previous times the Fed raised rates?

Of course you can. And that's what I'm going to do in the next few lines....

Let's start at the end of the 1990s, when the Fed started raising rates in June 1999 and then made 5 more successive increases until 2000.

What did the S&P500 do in the meantime?

The index peaked in September 2000, then AFTER the 5 subsequent Fed increases.

In essence, the S&P 500, which had already reached respectable prices in 1999, ran another 12% from the rate hike to its final peak in 2000.

In addition, the index, after making a correction from its peak, reached new highs again over the next 15 months.

A similar scenario occurred before the 2008 financial crisis...

When the Fed started to raise rates in June 2004, the US stocks started to rally for several years afterwards.

Specifically, there were 17 rate hikes from June 2004 through mid-2006. But during all that time, investors made gains of 46% before stocks peaked in October 2007.

Let's turn now to more recent examples.

Also in late 2015, the Fed began a new round of rate hikes, eventually running 8 successive increases between late 2016 and late 2018.

In this case, U.S. stocks rose almost 80% from the beginning of 2016 to their peak in early 2020... And we all know what caused this run to stop. Certainly not rising interest rates, but COVID-19....

So history shows that the stock market does not react immediately to a rate hike, but keeps grinding strong rises before hitting the trend peak.

In the most recent example we cited (2016-2020), the market didn't even peak, but simply remained in a multi-year fixed uptrend before stopping due to an exogenous setback (the Covid 19).

So if history teaches us anything, we have to assume that this time too, in the worst case scenario, the markets will remain in a bull trend for months after one or more rate hikes by the Fed.

The Fed could raise interest rates twice in 2022 and perhaps a few more times the following year. But it is very likely that the market, after a predictable correction caused by the "news" each time, will resume its run, at least for a few months, if not a few years, until it reaches some peak.

And these trends that history shows us are certainly not something magical.

It's not that stock markets react this way on a whim of fate or the will of the gods....

There is a very rational reason behind the surprisingly consistent behavior that stock markets are showing in the face of Fed rate hikes.

The reason is what I said at the beginning, that any rate hike by the Fed (or any other central bank) can only be sporadic and NEVER implies a real change in the accommodative policies started back in 1999 and now the only source of stability for any government's finances.

As long as all the financial, political and social parameters within which the 21st century world has been set will not change, stock exchanges will never really take rate increases seriously.

Thanks for reading

Posted Using LeoFinance Beta

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