The U.S. stock market has shown resiliency over the past two years, from weathering the events of a global pandemic in 2020 to facing the surging inflation and high commodity prices we are experiencing today. The central bank implemented emergency policies at the onset of the pandemic to help stabilize the economy. Fast forward to today, where the Federal Reserve is beginning to implement tighter federal policy to help curb the increased inflation rate. What actions are being taken and how do they affect the stock market?
To set the scene, interest rates have been at historic lows since they were reduced in March of 2020. This allowed the economy to deal with all the events that took place during the pandemic. Just over two years later, the economy is still trying to find its way after the shakedown of Covid 19, and as a result the inflation rate has soared. Therefore, the Federal Reserve raised interest rates in March for the first time since 2018, raising the rate by 25 basis points (.25%). To follow that, the central bank raised rates by another 50 basis points earlier this month. This recent interest rate hike was the biggest move in 22 years.  And more rate hikes have been hinted at throughout the remainder of the year. Interest rates are being increased to slow down the rising inflation rate. It is important to understand that the stock market has experienced many rate hikes, and equities have risen during those times. But is this time different?
The real concern that many have comes from the worry that surging inflation paired with sky-high commodity prices could force the feds to enact tighter policy, causing the economy to slow. But it’s important to understand that one of the main goals is to lower the inflation rate. As a consumer, your purchasing power for goods and services lowers when inflation increases because prices rise. To keep this in check, rate increases and decreases work to control prices. Can this cause a brief slowdown in the economy? Yes, but it is necessary to let prices adjust and stabilize to normalized levels. How long does it take for the economy to adjust?
In general, there is a 12-month lag in the economy, which means it will take at least 12 months for the economy to feel the effects of any increase or decrease in interest rates. Understanding the big picture allows one to interpret modest adjustments in stride. All in all, the Federal Reserve adjusts rates higher or lower to keep the economy in balance over the long term.
Looking at the numbers, dating back to January 1990 there have been five occurrences of interest rate hikes of at least 50 basis points (.50%). The average return following a rate hike of at least ½ percent has been positive four out of the five years. Taking a look at 2022 so far, the S&P 500 index is down more than 10%, but less than 20% from an all-time closing high of 4797 set on 01/03/2022, signifying a “correction.” This marks the fifth correction since 2015. All in all, a market drawdown is a normal part of the investing process. Keeping a long-term view on investing and sticking to your goals and objectives will ease the anxiety towards any short-term volatility.