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Why You Care If Today is the Date the Federal Funds Rate Increases

Posted by kdadmin on December 16th, 2015.

Why You Care If Today is the Date the Federal Funds Rate Increases

Winston Churchill once said, “The farther back you can look, the farther forward you are likely to see.” Now, I am required to say that “Past performance is no guarantee of future results.” However, take a look at the chart I posted six weeks ago, just before the last Fed meeting announcement. It shows the 20 year history of the Federal Funds Rate compared with the performance of the S&P 500 and inflation.

Do you … notice anything?

Federal Funds Rate & S&P500: Summarizing a 20 Year Backstory.

Both in 1998 and 2004, when the Fed started to raise the Federal Funds Rate, the S&P 500 (here, SPY) ticked up for a short bit until the rate stabilized, then within about a year or so of a steady Fed rate, SPY tanked. And hard. I circled these trends.

Notice anything else? The price of SPY is over 30% higher than either of the two prior peaks. Ever heard the phrase, “The bigger they are, the harder the fall?” If the Fed wants to hit its “equilibrium target” of 3.5%, in two years, that means a sharper, faster rise than either of the two prior peaks. Such a goal is more on scale with the 2004 to 2008 cycle than the 1998 to 2001 cycle. And, if you recall, 2008-2009 wasn’t called The Great Recession for nothing. You can read the full story from my previous article here.

Why You Care if Today is the Date the Federal Funds Rate Increases.

  1. If the Feds start their cycle today, it gives us a pretty clear picture of what the future is likely to hold.
  2. If not, we’re left with that “uncertainty” thing that makes the markets nuts and volatile. This is how the market works.
  3. You can see why some sophisticated research houses put some upside potential on the stock market over the next couple of years, while interest rates rise. It’s not much. Maybe 10% over two years. This is a hair away from bond territory, which carries far less risk (except high yield bonds).
  4. But after those two years, LOOK OUT BELOW.

With estimates that the market has priced in an 83% chance of a rate hike, a failure to raise rates could, counter to macroeconomic theory, actually cause a sell off in the market. It’s a tough call today and why I’m happy to watch the show from my defensive cash and bond compound …

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