- The Fed announced Wednesday it was leaving the target rate unchanged at 0%-0.25%.
- The Fed is still cautious about withdrawing stimulus too quickly—a good thing.
- But it's easy to worry the bull market will be threatened when the rate tightening cycle begins.
- Investors can expect the Fed to raise rates eventually, but, historically, initial rate increases haven't doomed stocks.
The Federal Open Market Committee held the fed funds target rate at 0% to 0.25%, after its two-day meeting concluded Wednesday, and released a statement about…nothing much new. Besides again noting obvious signs of continued economic recovery, including "growth in household spending" and "significantly rising" business spending, the FOMC also noted the previously announced conclusion of several emergency liquidity facilities went as planned. (This includes the Fed's Mortgage-Backed Securities Purchase Program, which ended March 31st without a huge jump in mortgage rates as feared.) Only the facility for commercial mortgage-backed securities remains, but is scheduled to close June 30th.
All is well—which is nice to hear, and perfectly appropriate—but boring. Let's get to the meat of the matter.
The Fed's target rate and thus short rates generally have nowhere to go but up. The question is when and to what end. Recovery is proceeding quite well, thank you, but how much of that is due to a heavy dose of loose money? And what happens when the doc pulls the prescription? Well, historically—nothing too bad. In fact, pretty much a continuation of good things.
History tells us initial monetary tightening shouldn't be feared—since 1971, US stock market returns 12, 24, and 36 months after the first rate rise in tightening cycles are overwhelmingly positive, averaging 4.9%, 16.9%, and 31.4%, respectively.*
S&P 500 Return Following Fed Funds Target Rate Hikes
Monetary tightening cycles can be likened to putting on a loose tie (exceptionally loose in this case)—it's not the first, initial tightening that chokes, or even comes close to choking. It's over-tightening down the road. In other words, it's premature to worry about over-tightening before we've even begun. The Fed could hike its target rate several times from here and it'd still be very low.
Globally, monetary policy overall remains accommodative, even as some central banks have already started the raising interest rates. But unlike the nearly coordinated global tie loosening, tightening will likely be determined by local recoveries. Emerging economies, for instance, are leading recovery in the developed world, and a few have already begun reining in excess liquidity by raising rates. That's perfectly fine and to be expected.
As the economic recovery gains steam here and abroad, investors can expect gradual monetary tightening and rate hikes—but don't expect that to stop stocks in their tracks.
*Source: Federal Reserve, Global Financial Data, Inc. Price level returns.