Federal Reserve: Will an earlier liftoff rattle markets?

Federal Reserve_Will an earlier liftoff rattle markets



The Fed is accelerating its tapering process and could raise rates sooner than expected in 2022. For investors, however, rate hikes driven by a growing economy have historically been nothing to fear.

The federal funds rate
Fed funds rate (lower bound) since 2002 and the FOMC's projections

Federal Reserve_Will an earlier liftoff rattle markets

Source: Clearnomics, Federal Reserve, Principal Global Investors. Data as of December 8, 2021.

Investors have shifted their expectations for Federal Reserve (Fed) policy. Less than a month after it began to taper its monthly asset purchases, Fed Chair Jerome Powell hinted that the Fed may accelerate its tapering process. This means that the Fed's balance sheet expansion could end ahead of schedule (by early 2022) and sets the stage for the first Fed rate hike to follow soon after.

Driven largely by inflationary pressures, the change in the pace of purchases naturally raises concerns among investors. If markets have performed well riding the coattails of robust Fed stimulus, doesn't its removal mean that stocks could reverse course?

Tapering and tightening is both a natural part of the economic cycle, and an environment where markets can still perform well. The Fed usually hikes rates only if the economy is growing significantly, and that same growth is what drives corporate earnings and stock market returns.

For example, the S&P 500's average annual total return was 10.5% from 2004 to 2006 when the Fed hiked rates 17 consecutive times—a significantly sharper hiking cycle than the 4-6 hikes we anticipate in 2022-2023. Even during the last rate hike cycle (2016-2018), the S&P 500 averaged 9.8% annually. While the past is no guarantee of the future, history does not suggest that rate hikes are a reason to believe that a market correction is imminent.


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