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CNBC ON DIGG

Will a Fed Rate Hike Lift or Sink the Markets?

Published: Tuesday, 3 Nov 2009 | 9:59 AM ET

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By: Yolaiki Gonzalez
Market Data Analyst

The Federal Open Market Committee (FOMC) meets today for the tenth time this year and there are growing expectations that the U.S. Federal Reserve and other central banks may be considering raising their key rates sooner than later amidst hopes of economic recovery.

Now that two major central banks, the Bank of Australia and the Norwegian Bank have begun to tighten their monetary policies in October, each by lifting their borrowing benchmark rates by 25 basis points, more pressure will be added to the FOMC to consider a rate increase in the near future. However, it's expected that the Fed will leave interest rates unchanged this time.

When they do decide to lift rates in the future, will the equity markets welcome the increase?

The U.S. Federal Reserve’s overnight rate at which depository & financial institutions lend to one another is currently is at an all-time historic low range of 0-0.25%. Since July 1990, the Fed has made changes to its monetary policy, through tightening or easing of its benchmark rate 78 times. Over the course of the current recession that began at the end of 2007, the Fed has cut its benchmark rate by nearly 525 basis points. The most recent rate cut that took the Fed Funds target to its current level occurred on 12/16/08 and led gains in the S&P [SPX Loading... () ] of 5.14%, 4.2% in the Dow [.DJIA Loading... () ] , and 5.41% [COMP Loading... () ] in the Nasdaq Composite for that day.

Tightening vs. Easing

Tightening: Since the early 1990’s, the Fed has tightened its benchmark rate 31 times. The Dow, S&P, and Nasdaq Composite have posted avg. gains of 0.18%, 0.24%, and 0.31% on those occurances, and each were up more than 51% of the time.

Dow:

1 month later: Up 52%, Down 48% of the time, avg loss of -0.49%
3 month later: Up 61%, Down 39% of the time, avg gain of 1.25%
6 month later: Up 67%, Down 32% of the time, avg gain of 3.67%

S&P:

1 month later: Up 48%, Down 52% of the time, avg loss of -0.35%
3 month later: Up 68%, Down 32% of the time, avg gain of 1.94%
6 month later: Up 77%, Down 23% of the time, avg gain of 4.4%

Nasdaq:

1 month later: Up 55%, Down 45% of the time, avg gain of +0.41%
3 month later: Up 71%, Down 29% of the time, avg gain of +3.24%
6 month later: Up 68%, Down 32% of the time, avg gain of +7.68%

Easing: Since the early 1990’s, the Fed has cut rates 47 times. The Dow, S&P, and Nasdaq Composite have posted avg. gains of 0.19%, 0.39%, and 0.65% on those occurrences, and each were up more than 45% of the time.

Dow:

1 month later: Up 53%, Down 47% of the time, avg gain of 0.81%
3 month later: Up 62%, Down 38% of the time, avg gain of 1.58%
6 month later: Up 53%, Down 47% of the time, avg gain of 2.85%

S&P:

1 month later: Up 60%, Down 40% of the time, avg gain of 0.78%
3 month later: Up 62%, Down 38% of the time, avg gain of 1.44%
6 month later: Up 57%, Down 43% of the time, avg gain of 1.86%

Nasdaq Composite:

1 month later: Up 64%, Down 36% of the time, avg gain of +2.07%
3 month later: Up 64%, Down 36% of the time, avg gain of +5.53%
6 month later: Up 62%, Down 38% of the time, avg gain of +7.22%

In addition, the central bank has changed the direction of its monetary policy 8 times in the past 19 years. Whenever the Fed changed its direction for the first time by hiking its rate, the major indices posted larger than average gains over the 6 months that followed, versus smaller than average gains when the Fed first slashed its rates.

See table below for Target rate levels, and basis point changes.