The Federal Reserve meets today in Washington to discuss interest rate policy. As the Fed readies to raise rates, perhaps later this year, it is a good time to review how markets have historically performed amid Fed tightening.
For stocks, the speed of rate hikes has been important. When the Fed raises rates quickly, usually in response to inflation pressures, stocks have struggled. When the Fed raises rates slowly, stocks have tended to fare reasonably well.
In recent years, the Fed has consistently surprised investors by being slow to withdraw stimulus. Accordingly, we expect the Fed to raise rates slowly. The critical risk would be the potential for rising inflation to pressure the Fed into tightening rates quickly. Presently this scenario is not an immediate threat, with inflation well below the Feds 2% threshold.
Historically, the weakest period for the bond market is before the Fed raises rates. After the Fed begins raising rates, bond market returns have been modestly positive, on average (table). In Wall Street jargon, this is referred to as sell the rumor, buy the news.
Rates have risen and bond prices have fallen in recent months as the Fed readies to hike rates (see performance table). The risk of rising rates has been present for several years, and we believe Hefren-Tillotson client portfolios are positioned to address this dynamic.