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The Fed is Already Three Months Into its Newest Rate-Tightening Cycle

Since the FOMC raised rates on 12/16/15, the S&P 500 has endured a tremendously volatile ride. Indeed, it has recorded 32 trading days in which the Index rose or fell by 1% or more, which is nearly twice the average quarterly volatility since 2000.

Also, the S&P 500 suffered through a 12% decline in price from 12/29/15 - 2/11/16. Since then, the market has rebounded more than 10.5% and now about 5% below its all-time high of 5/21/15.

Looking at total returns for global asset classes from 12/15/15 through 3/11/16, the higher-yielding groups have performed the best, led by the S&P MidCap 400 Dividend Aristocrats (+8.7%), while the broader benchmarks lost ground. From a sector perspective, the higher yielding groups such as Telecom Services (+15.8%), and Utilities (+15.1%), led, while the more cyclical sectors like Tech (-2.3%) and Financials (-5.8%) declined.

S&P Global Asset Class/S&P 500 Sector Total Returns Since the FOMC Started Its Newest Rate-Tightening Cycle

How high the Fed ultimately pushes up interest rates is anyone’s guess. However history says, but does not guarantee, that rates could rise by as much as 200 basis points before all is said and done. Since 1946, the Fed has initiated 17 rate-tightening cycles. The median increase was 1.6 percentage points, but actual rate hikes ranged from as little as 0.25% to as much as 7.75%. In addition, the median total increase in short-term rates was 43% of the starting CPI level.

However, that number jumped to 107% when CPI was higher than the starting short-term interest rate, such as it was in 1958, '71, '77, '80, and 2004. The year-over-year change in Core CPI was +1.9% in December 2015, so history implies that the Fed could push rates to around the 2% level.

So there you have it. The Fed has raised rates once in this newest rate-tightening cycle, and now expectations for future rate increases in 2016 have been cut to two from four. As a result, higher yielding global asset classes and S&P 500 sectors have outperformed the broader benchmarks since 12/15/15.

We see no “one and done” rate-tightening cycle this time around, such as in 1971, 1984 and 1997, but we do think the Fed will embrace a more normal recessionary monetary policy. Therefore, the Fed won’t take away the punch bowl, they’ll just stop refilling it.

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