How Have Fed Rates Affected Stock Markets in the Past?
The Federal Reserve, or the Fed, is the central bank of the United States. It has the power to set the federal funds rate, which is the interest rate that banks charge each other for overnight loans. The federal funds rate influences other interest rates in the economy, such as mortgage rates, credit card rates, and bond yields.
The Fed adjusts the federal funds rate to achieve its dual mandate of promoting maximum employment and stable prices. When the economy is weak, the Fed lowers the rate to stimulate growth and spending. When the economy is strong, the Fed raises the rate to prevent inflation and overheating.
But how does the Fed's monetary policy affect the stock market? The answer is not straightforward, as there are many factors that influence stock prices, such as earnings, expectations, sentiment, and risk appetite. However, we can look at some historical examples of how the Fed's rate changes have impacted the stock market in the past.
One of the most famous episodes was in 1987, when the Fed raised the federal funds rate from 6.75% to 7.25% in September, amid concerns about inflation and a weakening dollar. This contributed to a sharp sell-off in the stock market on October 19, known as Black Monday, when the Dow Jones Industrial Average plunged 22.6% in a single day.
Another notable example was in 1999-2000, when the Fed raised the federal funds rate from 4.75% to 6.5% in six steps, as the economy was booming and the dot-com bubble was inflating. This tightening of monetary policy helped to burst the bubble and trigger a bear market that lasted until 2002.
On the other hand, there have been times when the Fed's rate cuts have boosted the stock market. For instance, in 2001-2003, the Fed slashed the federal funds rate from 6.5% to 1%, as the economy was hit by a recession and the aftermath of the 9/11 attacks. This easing of monetary policy helped to stimulate a recovery and a bull market that lasted until 2007.
Similarly, in 2007-2009, the Fed cut the federal funds rate from 5.25% to near zero, as the economy faced a severe financial crisis and a deep recession. This unprecedented stimulus helped to stabilize the financial system and support a rebound in the stock market that has continued until today.
In summary, the Fed's rate changes have had significant effects on the stock market in the past, but not always in predictable ways. The direction and magnitude of these effects depend on various factors, such as how much and how fast the Fed changes rates, how expected or unexpected these changes are, how they affect other interest rates and exchange rates, how they influence economic growth and inflation expectations, and how they interact with other events and shocks in the economy and the world.