GO AHEAD, FED, HIKE THE RATE: WE’RE NOT AFRAID
Wall St. unusually confident it can bear a June increase, but big risks remain
Either stock investors are in denial, or coming interest rate hikes from the Federal Reserve won’t do irreparable damage to the second-longest bull market in Wall Street history as feared.
After six months of the U.S. stock market going nowhere (a gain of 0.8%, to be exact) following the Fed’s first rate hike in nearly 10 years back in December — not to mention constant chatter from stock pundits about how stocks won’t do well when the Fed resumes raising rates, now pegged at 0.5% — Wall Street is now acting as if a coming rate hike is no big deal.
The mood shift is evident in the sudden spike in stock prices (the Dow has rallied about 360 points the past two days). It’s also driven home by the spin from Wall Street, which is akin to traders looking Federal Reserve Chair Janet Yellen in the eye and declaring, “I’m not afraid of you, the Fed or higher interest rates!”
That emerging optimism among stock traders is in stark contrast to the way the market reacted last week when the minutes of the Fed’s April meeting put a June hike very much back on the table. That more hawkish Fed message has been reinforced by many Fed speakers in the days that followed, with some Fed members calling for as many as three rate hikes in 2016 and more to come next year. While the threat of more Fed rate hikes, perhaps as early as June, hasn’t caused a bear market in stocks, it clearly has slowed the momentum of the broad equity market, which has gone more than a year since hitting its last record high.
Indeed, the new “I’m not afraid of rising rates” messaging started Tuesday. The Dow Jones industrial average shot up more than 200 points that day after Wall Street got word that April newhome sales rose to their best levels in eight years. Bob Doll, chief investment strategist at Nuveen Asset Management said investors were starting to get used to the idea of a rate hike.
And from there Wall Street started to come up with reason after reason why Fed rate hikes weren’t necessarily a death sentence for stocks.
David Bianco, a stock strategist at Deutsche Bank, wrote in a report that “a summer hike is fine, provided the Fed doesn’t hike again until December at the earliest, after the presidential election.”
Jim Paulsen, chief investment strategist at Wells Capital Management, said “slow but steady” rate hikes “will be good for stocks,” as it will signal the Fed’s “growing confidence” in the global economic recovery.
The emerging bullish storyline, however, comes with caveats.
First, performance statistics show that while the Standard & Poor’s 500 stock index has eked out an average gain of 0.9% in the six months after the Fed’s first rate hike and a 4.5% return 12 months later, those returns are less robust than the far more sizable gains after the first rate cut, when stocks were 11.6% higher six months later and 15.2% a year later, according to data dating to the end of 1945 supplied by S&P Capital IQ.
The fact is stock performance is less robust when the Fed is in rate-hiking mode. And despite the recent whitewashing of Fed-related risks, there are still many ways the Fed can err and cause financial pain.
The biggest risk is if the Fed hikes rates not once but two or even three times this year. Right now, while there’s a 32% chance of a Fed hike in June, no other hikes are currently priced in.