Federal Reserve Rate Increase: Impact on Stocks

Big news came from the Federal Reserve recently, as its new chairman, Jerome Powell, announced that rates were being hiked a quarter of a percentage point (to a range of 1.5% to 1.75%). This is the highest level attained in the past decade.

The big question on Wall Street was whether the Fed would employ four interest rate hikes in 2018. Powell put those fears to bed by confirming they’d stick to the original forecast of three increases. While this was good news, it wasn’t good enough to prevent stocks from dipping after an initial spike.

As pointed out by Forbes, the lack of interest rate increases over the past several years has allowed more businesses to finance projects with inexpensive capital. But this strategy was far from a silver bullet – the economy has crawled along at just 2% growth.

The stock market, on the other hand, boomed. So it’s worth noting that after the most recent Fed announcement, the Dow Jones industrial average went from a 130-point gain prior to the announcement to a 250-point gain. But as they say, what goes up must come down. Ultimately, the stock index sunk 45 points.

What does this mean for stocks in the future? This most recent announcement revealed that smaller stocks are more resilient amidst rate increases. These types of stocks have less access to capital compared to their bigger competitors, so the news that there will be fewer increases in 2018 is music to their proverbial ears.

Across the board, there’s temptation on Wall Street to sell. This is because wages typically go up as the economy grows and unemployment dips. Companies jostle and compete for employees in a financial climate like this, which Wall Street fears will lead to inflation and additional interest rate increases.

The long and short of it is that interest rates have an unparalleled impact on stock prices. Ultra-low interest rates have taken the market to soaring heights, illustrating one half of that correlation. And as those rates now climb steadily upward, the inverse could be true.

What exactly the future holds for the stock market is yet to be seen. But it’s clear that future rate increases will play a key role as Wall Street and the Fed continue their delicate dance of trying to maximize the good while simultaneously fending off inflation.