As rising policy rates may mean lower inflation levels and slower economic growth in the future, long-term rates may ease when the Fed hikes, supporting the performance of the Treasury market. Relatively high levels of coupons and yields prevailing for much of the analysed period also acted as a cushion for Treasury investors.
When comparing the relative performance of US stock market with US Treasury market in the aftermath of a change in Fed policy, the results are more nuanced. Out of the 21 rate hike cycles in our study, the US stock market outperformed the Treasury market 15 times – a 71 per cent hit rate – in the 12 months after the first hike and 11 times – a 51 per cent hit rate – in the six months after the first hike. This further highlights the need to consider all factors and the context of the change in policy and to consider using dynamic asset allocation that can adapt to market conditions as the rate hike cycle develops.
The US dollar appreciated against major currencies
The US dollar tended to appreciate against major world currencies over 12-month periods, but depreciate over six-month periods after a first hike. Out of the 21 rate hike cycles since 1974, the US dollar has appreciated 12 times – a 57 per cent hit rate – in the 12 months after the first hike and eight times – a 38 per cent hit rate – in the six months after the first hike.
While rising rates may attract foreign investors, boosting the demand for the currency and its value, a number of interrelated factors affect currency movements. Notably, political and economic stability, and the demand for a country’s goods and services, often have a bigger impact on exchange rates than interest rates.
Once again, historical currency fluctuations demonstrate that investors should not make decisions solely based on Fed policy but rather consider other potential drivers of the performance of asset classes and currencies.
History tells us that the beginning of a policy rate-hiking cycle by the Fed does not tend to derail the US stock or bond markets, nor the US dollar. However, while this is good news for investors, it does not amount to a guarantee that those markets will perform well at the beginning of the next Fed hiking cycle.
Although Fed rate decisions are very important, investors should consider other ways the Fed influences the economy and investment markets beyond its policy rate, as well as the impact of policy on sentiment and other factors that set the scene for the expected performance of markets.
Other sources of investor anxiety
