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What Should I Think About the Fed Rate Increase?

What Should I Think About the Fed Rate Increase?

March 28, 2022

I suppose you have heard about the March 16 Federal Reserve announcement. The Fed increased interest rates for the first time since December 2018 with a 25-basis point hike (0.25%). Several more hikes (up to six) are expected later this year. So, what does this mean for you and your financial goals?

Of course, the answer is that it depends. It depends on your goals and priorities. As an advisor who is always my client’s advocate – a fiduciary advisor -- I constantly focus on the client’s goals. So if you would like to talk about your specific situation, follow this LINK to find a time for us to talk.

Otherwise, below is a little context on rate increases and what you should expect.

What is The Federal Reserve Up To?

Fed Chairman Jerome Powell says he is focused on inflation. One technique to reduce inflation is to raise the Fed Funds rate, which should make borrowing more expensive for everybody, which should make people spend less, which should reduce the demand for goods and services, which should reduce prices. As you can see, it’s not a very direct process.

Some experts are talking about the possibility that if interest rates rise too much, the U.S. economy might shrink for two quarters or more – that’s a recession. One of the worst things about a recession is that many companies cut back and put people out of work. When people lose their jobs, lots of bad things can happen. So, nobody loves the idea of curing inflation with a recession.

The charts below, from Goldman Sachs, plots the Fed’s previous rate hike cycles and whether they led to a soft landing, a recession, or something in between.

Fed's Chart from Goldman Sachs

What Could Happen Next In The Markets?

Investors need to remember that Fed rate hikes usually occur near the middle of the economic cycle, which means there may be years of growth ahead for stocks and the economy. History tells us that generally, market returns have been relatively strong a year after the first hike in a cycle, with an average return of 9.2%. In looking back to 1983, market returns have been positive 12 months after the first rate hike 87.5% of the time. So, that’s not too bad.

S&P 500 index future returns

Source: LPL Research, Bloomberg 2/1/2022. All indexes are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results.

So, increases in interest rates don’t necessarily mean bad things for investment markets. But, what if we raise rates consistently over the next two years, as some people expect?

Two factors to consider:

  • Markets hate surprises, and these rate increases are NOT surprises, so that should help the markets move forward.
  • We are starting from 0.25% Fed Funds rate, so even with 8 increases, we would be looking at a Fed Funds rate around 2.25%, which is below historical averages.

The table below shows the stock returns in past rate increase cycles. Looking back to the Second World War the median annualized return is 5.6% during the rate hike cycle.

S&P 500 index future returns 2

Source: LPL Research, Bloomberg, CFRA 3/15/2022. *Study looks at 5 or more rate hikes in a cycle.

All indexes are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results. Performance back to 1950 incorporates the performance of predecessor index, the S&P 90. The modern design of the S&P 500 stock index was first launched in 1957.

Talking About 4 or 5 Rate Hikes This Year? It Has Happened Before

As we look back to 1970, back to the days when we REALLY had inflation, we see history of plenty of rate hikes in one calendar year, as this chart shows.

Federal reserve bank rate hikes

Source: LPL Research, Bloomberg 1/27/2022

And, here’s a chart showing the historical returns for years with four or more rate hikes.

Federal reserve bank rate hikes 1970

Source: LPL Research, Bloomberg 2/1/2022. All indexes are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results.

Take special note of 2004-2006. There was a total of 17 rate hikes over those three years, and the S&P 500 showed a gain in each of those years.

The Bottom Line

The bottom line is rate hikes usually aren’t bad for markets, and experts I trust don’t expect the early part of this cycle to be any different. We are still at the top of a long market growth cycle. This phase is usually extra volatile. And now we have a war in Ukraine. So, expect lots of big moves in indexes.

If you have a specific need for money in the next 12 months, you should probably have that money in cash. If your goals are 3 years or more, you should stay calm and expect the markets to bump and jostle their way through these challenges and move forward over time.

Clearly, there is a lot to consider and plenty to think about. I suggest you take time to visit with a CERTIFIED FINANCIAL PLANNER™ professional. These folks have training, experience, and resources to help you sort out your options and make great choices.

Yes, I am a CFP® professional. I’m always a fiduciary and I work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice. If you would like to talk about your situation, follow his LINK to find a time for us to talk.

If this article has you thinking about your own circumstances, contact my office at I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.