Defying the Bear: Understanding Market Reactions to Interest Rate Decisions
Uncovering the historical patterns of stock market reactions to interest rate hikes and the implications for investors
It's a common belief among investors that the stock market will decline following an interest rate hike, but as we'll explore, it's not always that simple. In this article, we'll delve into the historical patterns of market reactions to interest rate decisions, focusing on the US crashes of 2000 and 2008, and Japan's crash in 1990. This is not meant to serve as a forecast, but rather to offer perspective on the historical outcomes of these events.
First Rate Hikes to True Top
Our examination of historical data from 1989, 2000, and 2008 reveals that it's typical for rate hikes to occur approximately a year before the actual market peak. This pattern is evident in the US crashes of 2000 and 2008, as well as Japan's crash in 1990.
Here's a summary of the interest rate decisions and subsequent market reactions during those years:
In 1988, the Bank of Japan raised its official discount rate from 2.0% to 2.5% on April 1, 1988. The Nikkei 225 index peaked on December 29, 1989, around 21 months after the first hike.
In 1999, the Federal Reserve raised the federal funds rate from 4.75% to 5.5% between June 1999 and May 2000. The S&P 500 index peaked on March 24, 2000, approximately 10 months after the first hike.
In 2007, the Federal Reserve raised the federal funds rate from 4.25% to 5.25% between June 2006 and June 2007. The S&P 500 index peaked on October 9, 2007, roughly 16 months after the first hike.
Averages and Implied Forecasts
Assuming the first rate hike occurred in September 2022, the average forecast for the high would be around June 2023, with an implied forecast of May 2024, assuming the repetition of historical patterns. Typically, a crash would follow 6-9 months later.
Paradoxical Reactions
Interestingly, historical data shows that markets often rally following the initiation of rate hikes, and in some cases, rate cuts have signaled the real high (within 5-10%). For example, the S&P 500 index peaked on September 3, 1929, after the Federal Reserve had cut the discount rate from 6% to 5% in August of that year. Similarly, the market peaked on January 14, 2000, after the Federal Reserve had cut the federal funds rate from 5.5% to 5.25% in May 1999.
A breakdown of the data for Japan and the US reveals the following:
Time from first rate hike to market top: 13 months (Japan), 14 months (US, 1999), and 19 months (US, 2006)
Time from first rate hike to the start of the big market crash: 25 months (Japan), 24 months (US, 1999), and 22 months (US, 2006)