Interest Rates: How Will The Stock Market Respond To A 0.5% Increase?

The Federal Reserve is considering an interest rate hike at its March meeting that could be as high as 0.5%. We haven’t had a rate increase that high since the dot-com bust in 2000. If we did have a half-point rate hike, how would the stock market perform?

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The consumer price index rose 0.6% in January from the prior month and 7.5% vs. a year ago, the biggest annual gain since February 1982. Rising inflation prompted the Federal Reserve to turn more hawkish. Treasury yields jumped and the stock market, particularly the tech sector, took a beating.

As of Tuesday, the odds for a rate hike of 0.25% to 0.50% was 42%, compared with 58% for an increase of 0.50% to 0.75%, according to the CME Group’s FedWatch tool, which tracks interest rate futures. But on Thursday, the odds for a quarter-point hike were higher than for a half-point increase.

Market Performance Around Interest Rate Hikes

A study conducted by Dow Jones Market Data analyzed how markets reacted to the last five interest rate hikes of 0.50% or more, both before the hikes were announced and in the weeks and months that followed. The results are below.

Since June 1989, there have been a total of five rate hikes of 50 basis points or more. The most recent was in May 2000. Before that, there were three rate hikes of 0.5% in February 1995, August 1994 and May 1994. There was one 0.75% rate hike in November 1994.

As you can see, the markets reacted negatively to the rate hikes both two weeks before they were announced and two weeks after. But after the two-week period following the hikes, the stock market gained, in some cases sharply.

Have Markets Changed Since The Dot-Com Bust?

Granted, the economy and the markets have changed since 2000. Still, looking at how the markets reacted historically to those rate hikes may give investors a glimpse at how the markets might react this time.

“Inflation this hot suggests the Fed could kick off their rate-raising cycle with a 50 bps move,” said Lindsey Bell, Ally Invest’s chief markets and money strategist. “That would create significant volatility in stocks. However, the market is seemingly pricing in that inflation is peaking and there are brighter days ahead.”

In other words, investors may expect some downside and volatility both in the two weeks before the Fed’s March 15-16 meeting and in the wake of that announcement. After that, history says to look for the market to bounce as the economy and markets absorb higher interest rates.

Follow Michael Molinski on Twitter @IMmolinski

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