WHAT TO EXPECT AFTER THE FIRST FED RATE HIKE
As the recovery moves along at a rate that no one in the government could have expected, preparations for an exit strategy are likely well in place inside the Federal Reserve – at least, we’d like to think so. History shows us that the first few months surrounding a rate hike are not the best in terms of stock market performance. Higher rates naturally leads to concerns about future equity returns and results in some risk aversion. This fear of rate digestion soon turns to euphoria, however, and stocks pick up momentum as duration from the rate hike increases. Like much of Fed policy, however, the Fed tends to be late to the game. They tighten too late into the game and cut too late. Luckily, by the time they begin to cut it is likely that the recovery train will be approaching full speed and after a few bumps in the road we can expect some pretty solid stock market returns:
Historical lessons when Fed starts to tighten. Our collective challenge will be to identify the start of tightening. But let’s keep it simple and focus on the first Fed rate hike, which normally flags the tightening phase. Note that Israel has already tightened, and Australia and Norway may tightenbefore year-end, too. The lessons from MSCI Europe performance around the first Fed rate hike are the following:
- Equity performance from 12 months prior up to 1-3 months prior to the first Fed rate hike are strong. Returns have been positive in 7 of 7 cycles since 1977 with average returns of 17% during the 12 months prior to the first Fed rate hike.
- The first hike typically leads to some indigestion with performance slowing ahead of the first Fed rate hike, and subsequent 3-month returns negative on average. The odds are also more mixed further out: subsequent 12-month returns averaged 10.4% with the market up in 57% of cases.
Source: MS Research
The Fed ain’t raising for many quarters my friend.
The only fly in the ointment of this historical analysis is the unprecedented role of capital flows since 1994. I would discount any historical data before then. Not sure I would draw any conclusions from 2-3 data points. Watch credit, FX and commodities when the hike begins … that will tell you more.
With nearly $53 trillion in total credit market debt how are we (government, consumers, business) going to service all of that debt with higher interest rates. I don’t see them raising rates for years for this fact alone. I could be wrong, but I do know that a very popular trade in the 90′s was to short JGB’s. That never seemed to pan out. It’s either low rates for a long time like in Japan or further dollar destruction to inflate our way out of this debt.
You are dreaming if you think the Fed is raising rates anytime soon. If they raise by Q4 2010 I’d be surprised
This economy is all based on easy money. No easy money, no recovery.
They should raise. I’ve made this case before here. And, it shouldn’t be the “Greenspan Crawl” either with 25 beeps a meeting forever. ZIP (Zero Interest Policy) reeks of a broken system. Raising rates would restore confidence that the U.S. actually has a real economy and at least somewhat legitimate way of life remaining.
The longer they wait, the harder it will be to pull away the pacifier. The longer you leave rates at zero, the more you solidify an economy built with zero rates and only sustainable at zero rates.
Also, if they raise short rates they might be very pleasantly surprised at how well the long end behaves. At this point they need something to defend the dollar because at this pace of governemnt spending coupled with a ZIP policy, there exists a dark unknown below .DXY 70 ish.