US stocks could face a tenure of weakness as the Federal Reserve begins a new interest-rate hiking cycle, with investors watching how far the central bank raises borrowing costs. They will also watch whether stringent monetary policy affects economic and corporate profit growth. The Fed last week raised its benchmark rate by a quarter point to a range of 3.75% to 4.00%, its first increase since 2023, on a unanimous vote as it seeks to reduce consistent inflation. While the S&P 500 remains near record levels after gaining more than 12% this year, history suggests stocks could pull back in the months after the first rate hike. Investors are considering the present cycle against prior periods, especially the sharp market plunge that followed the Fed’s 2022 hiking campaign.
What LPL And RBC Data Say About Post-Hike Pullbacks
The key question for stakeholders is not whether the Fed will continue raising rates, but how aggressively it will do so and whether stringent policy changes expectations for economic growth or corporate earnings.
“Our bottom line is (whether) the Fed’s actions have an impact on the market’s expectations for either economic growth or corporate profit growth,” said David Lefkowitz, head of US equities at UBS Global Wealth Management. “We don’t think the Fed has to hike that much. This is where the debate I think is going to be for the market: How much does the Fed have to hike?”
The Federal Reserve has hinted that another quarter-percentage-point increase could come by the end of the year, while stakeholders are also factoring in extra hikes in 2027. The stock market has remained buoyant. The S&P 500 has gained more than 12% this year and was near record levels on Wednesday. Strong corporate profits have helped offset several risks, including higher oil prices linked to the Middle East conflicts. This led to rising bond yields and the Fed’s more hawkish policy direction.
However, historical market data points to potential drawbacks after the starting of a rate hiking cycle. According to LPL Financial data covering six cycles since the Fed began announcing meeting outcomes in 1994, the S&P 500 has recorded a median decline of 2.6% three months after the first rate hike. RBC Capital Markets also found that the index experienced a meaningful drawdown in most of those cycles, generally not long after the initial increase. In five cycles, declines from S&P peak levels ranged between 8% and 14%, with the lowest occurring between one month and three and a half months after the first hike.
“The fact that we are starting this new phase keeps us vigilant for a near-term garden-variety pullback of 5 to 10% in the S&P 100, said Lori Calvasina, head of US equity strategy at RBC Capital Markets. The pattern does not necessarily point to a prolonged market plunge. Instead, stakeholders are focused on whether higher oil prices and borrowing costs have started to show up in economic data or earnings.
How This Fed Cycle Compares With The 2022 Bear Market
The 2022 hiking cycle remains a major reference point for investors because stocks eventually entered a bear market after the Federal Reserve began aggressively raising rates. The S&P 500 fell 25% from its peak that year, reaching its low roughly seven months after the first rate hike. Analysts see crucial distinctions between that tenure and the current environment.
The 2022 cycle was accompanied by recession concerns and an especially aggressive series of rate increases. “It was the scale of hikes in 2022 that spooked the market,” said Sam Stovall, chief investment strategist at CFRA. The present cycle is expected to be shorter and shallower. Fed funds futures on Wednesday hinted that rates could peak around 4.8% in a little over a year, implying total increases of just over 100 basis points or one percentage point.
“That compares with an average rate hiking cycle of just under two years since 1983, during which rates increased by 320 basis points”, according to Jane Gibbons, an equity strategist at Jefferies. During the 2022-2023 cycle, the Fed raised rates by 525 basis points. “The current hiking trajectory feels like a mid-cycle adjustment that still can be absorbed “from a growth perspective and hopefully labor market perspective”, said Mona Mahajan, head of investment strategy at Edward Jones.
Why Stocks Have Recovered A Year After Past Fed Hikes
Historical performance also shows that stocks often recover after the initial drop during a rate hiking cycle. LPL Financial data shows that S&P 500 was 6.8% higher on a median basis one year after the first hike. The index was positive a year out in every cycle examined except 2022-2023. “Historically, stocks do get a little jittery initially after the hiking cycles start,” said Jeffrey Buchbinder, chief equity strategist at LPL Financial. “Then they tend to calm down and return to the fundamentals of economic and earnings growth.”
Investors will nevertheless be watching economic data closely as the rate cycle develops. UBS’s Lefkowitz said he plans to monitor the ISM manufacturing index, particularly its new orders component, while assessing how the economy could affect stocks.
