Little new data, lots of chatter from Wall Street and no clear signals about what the Fed might do at next week’s FOMC meeting. The announcement, either no change or a rate increase, is expected on Thursday afternoon September 17th around 2 PM Washington DC time.
Those looking for some hint of what this might mean for the stock market can lean on a bit of history reported in the Economist this week. Since 1955 there have been 12 Fed tightening cycles, averaging two years each with an average increase of five percentage points. Typically recessions appears after three years, but not always. Given the changes in the economy, business cycles and inflation, 12 cycles are not enough observations to identify a pattern. One favorable piece of history is that in nine of the 12 cycles equity prices rose in the year after the start of a tightening cycle. One reason may be that the Fed tends to move when the economy is strong, earnings are climbing and it fears over-heating. Today earnings per share on the S&P 500 are roughly flat: the change from June 2014 to June 2015, based on available data, was -3.2%.
For those who prefer pictures to numbers, the chart shows the S&P 500 and the Fed Funds rate monthly since 1954 with recessions marked by the vertical lines. More often than not, rising rates lead to falling stock prices.
The story for bonds is simpler. From the early 1950s to 1982 bond yields rose and bond prices fell. Yields peaked in mid-teens for treasuries. Since the August 1982 peak yields have come down to their present rock-bottom level. While bond yields may not rise in lock-step with the Fed funds rate, we are at the zero lower bound and the next move will be up. The chart below shows the modern history of US treasury bonds and the Fed funds rate.
Those who prefer trading signals to economic history can look to the CME Group’s FedWatch which offers a probability distribution for the funds rate based on the Fed Funds futures market. As of Friday afternoon, the odds for the funds rate on September 17th were 77% for 25 bp and 23% for 50 bp. Looking ahead to the December FOMC meeting, the odds for 25 bp are 41%, 43% for 50 bp and 16% for 75 or 100 bp.
Taking everything together, a rate hike is coming but no one knows when.
This article was written by David Blizter, Chairman of the Index Committee, S&P Dow Jones Indices.
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