The Fed lifted off zero rates with a 25 basis point (bps) hike. At the same time as they got off zero, they also released their “dot plot” – a survey of where FOMC members think that rates might go in the future.
The results were somewhat of a surprise. On average, FOMC members see themselves hiking rates to around 2% this year. That implies a 25 bps rate hike at each of the remaining six meetings in 2022 and possibly even one 50 bps hike.
So, was the stock market upset with this? Not at all! Stocks generally reacted positively to the news. But why? Shouldn’t higher rates be bad for stocks? The answer is complicated. Equity valuations tend to vary inversely with the level of long-term bond yields.
Part of the reason why the stock market has near record valuation levels is because long-term bond yields are still relatively low. But bond yields have been rising amid persistent inflation.
Hence the reaction to the Fed announcement. Higher short-term interest rates from the Fed might keep a lid on inflation expectations. Keeping a lid on inflation expectations might, in turn, keep a lid on long-term bond yields. Keeping a lid on long-term bond yields might allow the equity market to float to higher valuation levels. But higher inflation and higher bond yields remain a major risk.
OpenMarkets is an online magazine and blog focused on global markets and economic trends. It combines feature articles, news briefs and videos with contributions from leaders in business, finance and economics in an interactive forum designed to foster conversation around the issues and ideas shaping our industry.
All examples are hypothetical interpretations of situations and are used for explanation purposes only. The views expressed in OpenMarkets articles reflect solely those of their respective authors and not necessarily those of CME Group or its affiliated institutions. OpenMarkets and the information herein should not be considered investment advice or the results of actual market experience. Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss. Swaps trading should only be undertaken by investors who are Eligible Contract Participants (ECPs) within the meaning of Section 1a(18) of the Commodity Exchange Act. Futures and swaps each are leveraged investments and, because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade. BrokerTec Americas LLC (“BAL”) is a registered broker-dealer with the U.S. Securities and Exchange Commission, is a member of the Financial Industry Regulatory Authority, Inc. (www.FINRA.org), and is a member of the Securities Investor Protection Corporation (www.SIPC.org). BAL does not provide services to private or retail customers.. In the United Kingdom, BrokerTec Europe Limited is authorised and regulated by the Financial Conduct Authority. CME Amsterdam B.V. is regulated in the Netherlands by the Dutch Authority for the Financial Markets (AFM) (www.AFM.nl). CME Investment Firm B.V. is also incorporated in the Netherlands and regulated by the Dutch Authority for the Financial Markets (AFM), as well as the Central Bank of the Netherlands (DNB).
