Investors aren’t clamoring for a Fed rate hike, but there’s a chance an increase in interest rates could actually spark a renewed rally in stocks, according to some forecasters.
That’s the opposite of what typically happens when the Fed hikes. Higher rates tighten financial conditions and make the macro climate less favorable to risk assets. For stock investors, it’s largely interpreted as bad news, and markets think it’s the most likely scenario to emerge from the Fed’s policy meeting on Wednesday.
The odds of a 25 basis point hike have climbed to 92% in recent days.
It would mark the first time the central bank has raised interest rates in three years. But there are two main reasons a hike could actually be bullish this time around, analysts say:
Everyone is pricing it in. Stock investors have largely been expecting a hike for the past month. Even before the odds rose above 90% following the August consumer inflation report, markets saw about a 70% chance the central bank would deliver a hike.
Stocks have already been rattled by higher yields. Equities have been hit over the past month as investors fret over inflation and the prospect of higher interest rates. A steady rise in Treasury yields—the 10-year government bond yield hit the highest level since 2007 on Tuesday—has taken some of the air out of this summer’s rally.
The S&P 500 and Dow Jones Industrial Average are down 2% over the last month, while the Nasdaq 100 has shed more than 3%.
All three indexes also slipped below their 50-day moving averages as of this week.
A rate hike could help calm long-end bond yields. The bond market has come into focus amid concerns about inflation and the US’s fiscal health. The benchmark 10-year US Treasury yield recently surpassed the critical 5% level, a key threshold that signals fixed-income investors have turned more bearish on US debt.
But a rate hike could shift investors’ mindset, as it would signal the Fed is serious about bringing inflation back down to its 2% target. That could raise yields on the short-end while calming yields on the long-end, assuming that the Fed issues a rate-hike Scott Chronert, the head of US equity strategy at Citi Research, said this week.
“A pre-emptive move out of the Fed — 25, maybe 50 basis points — might not be the worst thing because it could anchor the longer end of the curve and put this current short-term uncertainty behind us,” Chronert said, speaking to CNBC this week about his outlook ahead of the FOMC meeting.
“Let’s call it the bullish shock effect,” he added of a potential surge in stocks on the Fed decision.
Thomas Lee, a market permabull and the head of research at Fundstrat, said he believes markets are primed for a positive reaction no matter what the Fed does at the end of its meeting. Stocks have already sold off ahead of the meeting, he wrote on Tuesday.
“If the Fed hikes, this is priced in. If the Fed is on hold, it is a surprise dovish move. Thus, we are expecting a positive reaction either way,” Lee said.
Henrik Zeberg, a veteran economist who studies business cycles, also said he believes a rate hike this week would be bullish for stocks in the short term. That’s partly because yields could ultimately fall on the news, sending risk assets higher, he wrote in a note published on Substack.
“Wednesday may be bullish no matter which door the FOMC walks through,” Zeberg said. “Falling yields and a falling dollar: the classic fuel of a bull market’s final advance.”