Do Rising Fed Funds Rates Cause Stocks to Fall?

With the news cycle being dominated by attention grabbing headlines regarding the Federal Reserve raising rates, many investors are asking questions about what stocks may do in the face of a rising rate environment. The “talking heads” have a lot of opinions on the matter with doom and gloom seemingly dominating the narrative. Instead of focusing on opinions, we focus on research. Here is some research from Dimensional that tackles this topic and will hopefully alleviate any concern over current and potential future fed funds rate hikes:

Surprisingly Benign: How Stocks Respond to Hikes in Fed Funds Rate

By Kaitlin Simpson Hendrix, Senior Researcher and Vice President | Trey Roberts, Associate, Research

On May 4, the US Federal Reserve increased the target federal funds rate1 by 50 basis points as part of what the central bank said will be a series of rate increases to combat soaring inflation in the US. Some investors may worry that rising interest rates will decrease equity valuations and therefore lead to relatively poor equity market performance. However, history offers good news: Equity returns in the US have been positive on average following hikes in the fed funds rate.

We study the relation between US equity returns, measured by the Fama/French Total US Market Research Index, and changes in the federal funds target rate from 1983 to 2021. Over this period of 468 months, rates increased in 70 months and decreased in 67 months. Exhibit 1 presents the average monthly returns of US equities in months when there is an increase, decrease, or no change in the target rate. On average, US equity market returns are reliably positive in months with increases in target rates.2 Moreover, the average stock market return in those months is similar to the average return in months with decreases or no changes in target rates.


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