Fed Raises Interest Rates For First Time Since 2023

The Federal Reserve raised interest rates for the first time in three years last Wednesday, lifting the federal funds rate by a quarter point to 3.75% – 4.00%. What surprised the market was not the hike itself, which was widely expected, but the unanimous 12-0 vote and Chair Warsh’s clear signal that more hikes may follow. Stocks initially fell on the news, rallied sharply Thursday, then finished mixed Friday. When the dust settled, the S&P 500 was roughly flat, the Nasdaq eked out a small gain, and the Dow and small caps took the brunt of the damage.

The drivers: First Federal Reserve rate hike since 2023, 10-year Treasury yield briefly topped 5% intraday, oil holding near $100, and Warren Buffett stepping down as Berkshire chairman.

The Federal Reserve raised interest rates a quarter point Wednesday, the first hike since 2023. Fed funds futures markets had all but priced it in going into the meeting, so the decision itself was hardly a surprise. What did surprise people was the 12-0 unanimous vote and the tone from Chair Warsh, who made clear that if inflation does not cooperate, more hikes may be on the way. That is a meaningful shift in the direction of monetary policy, and it is worth paying attention to.

Here is what is interesting though: the market barely blinked. Stocks fell Wednesday, roared back Thursday, and finished the week roughly where they started. It is worth noting that a good bit of Thursday’s snap-back was likely mechanical, as traders unwound the volatility hedges they had bought ahead of the Federal Reserve meeting. Friday then brought quarterly options expiration, known on Wall Street as “triple witching,” which typically adds noise to the tape as billions of dollars in contracts settle. With both of those forces now behind us, this coming week may give us a cleaner read on where the market really wants to go. So far, we have seen that the parts of the market most sensitive to interest rates, namely the cyclical stocks and small caps, took the brunt of the damage. The Nasdaq, home to companies whose earnings are growing fast enough to absorb higher rates, actually finished the week higher.

One more thing worth noting from our own sentiment work: there is a real disconnect right now between attitude and positioning. Numerous sentiment survey results show the consumer is feeling under pressure. With markets near all-time highs, investors are remaining meaningfully engaged. Historically, when attitude and positioning drift apart like this, it favors the market climbing its wall of worry.

Zooming out, the underlying story remains constructive. The labor market added 162,000 jobs in August, more than expected. Manufacturing has expanded for eight consecutive months. Services activity is at a six-month high. The largest capital spending cycle in American business history continues to accelerate, and the spillover into utilities and industrials is real. Corporate earnings have been growing. The consumer, while under pressure from higher prices, has been spending. None of that has changed to-date because the Federal Reserve raised rates by a quarter point.

The 10-year Treasury yield briefly topping 5% is the number worth watching. When long-term rates move meaningfully above 5%, they historically start to compete more aggressively with stocks for investor dollars. As such, mortgage rates rise. Corporate borrowing costs climb. The economy feels it. So far, the 10-year has poked its head above 5% and pulled back, suggesting the bond market may not be convinced that yields need to go materially higher from here. If that view holds, the pressure on stocks eases. If yields decisively break through 5%, that may be a different conversation.

A note on seasonality worth remembering: September has historically been the weakest month of the year for stocks, but October through December has been the strongest three-month stretch, going back nearly a century. The market has a habit of testing patience in September before potentially rewarding it in the fourth quarter. Notably, this particular calendar week has, in a number of past cycles, tended to coincide with the seasonal low before the traditionally stronger stretch that follows. That is anecdotal history, not a forecast, but the pattern is real enough to be worth mentioning. Volatility is likely to remain elevated in the coming weeks as investors digest the Federal Reserve’s message, keep a close eye on elevated energy costs, and watch for any new developments in the ongoing Iran war. Over the longer arc, earnings tend to drive stock prices. And earnings have been moving in the right direction.