July’s consumer price index (CPI) report received a warm reception from equity investors and Fed watchers. Inflation had fallen to its lowest level since 2021 (2.9% year-over-year), essentially paving the way for the first rate cut in years. Like clockwork, the chatter among investors was not if the Fed would cut rates at the September meeting, but by how much.
The ensuing 25-basis point vs. 50-basis point debate harkens back to 2023 and early 2024 when futures markets were forecasting six or more rate cuts for 2024, which was at the time double the Fed’s projection. Just about everyone was wrong. As it turned out, the stock market and the U.S. economy did not need lower interest rates to perform well. While the Fed funds rate has remained over 5% for the past year, GDP growth and market returns have been solidly positive.1
Nevertheless, with the Fed poised to cut interest rates at the September meeting, investors are once again being drawn into the narrative that lower rates are essential to stave off a recession and to keep the bull market going.
I still don’t buy that argument.
If we look at every bull market from 1950 onward, it’s easy to find several instances when interest rates were rising, the economy was expanding, and the stock market was going up—all at the same time. It happened in every bull market between 1950 and 1980, and notably from 2004 to 2006 and again from 2015 to 2019.
But you don’t need to be a market historian to find a time when rising interest rates aligned with rising stocks. It happened just over a year ago. In the chart below, readers can see the Fed funds rate (blue line), the 10-year U.S. Treasury bond yield (green line), and the S&P 500 index (red line) from March 2022 to August 16, 2024. In this period, interest rates have climbed, and so have stocks.
Source: Federal Reserve Bank of St. Louis2
To be more specific, from March 2022 to August 2024, this is what we’ve seen:
- Benchmark Fed Funds Rate: went from 0% to 5.25% – 5.5%
- 10-year U.S. Treasury Bond: went from 1.75% to 3.9%
- S&P 500 Index: went from 4,385 to 5,550 (up over +25%)
The idea that the U.S. economy and the stock market’s fate are in the Federal Reserve’s hands is simply not substantiated by what we know from history, or even from 2024. Interest rates have remained ‘higher-for-longer’ all year, and stocks have powered higher.
Monetary policy decisions are not meaningless, of course, but my argument here is that they are not as important as many investors think them to be.
In my view, what would hurt markets most is if inflation and inflation expectations start to drift higher and become un-anchored from their current 2.5% to 3.5% level, perhaps because of some unforeseen shock in geopolitics or the global economy. If the Fed is forced to go in the other direction—raising rates instead of cutting them because of a negative inflation surprise—I think that could be very detrimental to stocks. For now, however, inflation data continues to show the opposite, with gradually falling prices alongside signs of weakening in the jobs market—neither of which calls for higher rates.
Bottom Line for Investors
We know in the current environment that the Fed believes monetary policy is sufficiently restrictive, and with improving inflation readings and the unemployment rate rising from 3.7% at the beginning of the year to 4.3% in July, there is no expectation that interest rates will go any higher.
It’s also true that markets move on surprises, so if the Federal Reserve ended their September meeting with no rate cuts and a hawkish overall tone, I’d expect a volatile response from the stock market. But if the concern is whether the Fed will cut rates by 25 basis points or 50, and/or whether they will offer guidance for future rate cuts in November and December, I do not believe these are the outcomes influencing stocks most. Investors can frame market outlook in terms of shifting expectations around interest rates, but doing so means ignoring
Sources:
- MSN. 2024. https://advisor.zacksim.com/e/376582/nty-on-economy-fed-ar-AA1oR5UK/5rnv64/1004854014/h/ULpPPkTMOl6paVv1MMHY1qrsZfbyRpsK4lxorOHkkKE
- Fred Economic Data. August 19, 2024. https://advisor.zacksim.com/e/376582/series-DFF-/5rnv67/1004854014/h/ULpPPkTMOl6paVv1MMHY1qrsZfbyRpsK4lxorOHkkKE
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