How the Fed’s Rate Hike and the S&P 500 Index Correlate



Central bank decisions

The Federal Reserve started its gradual rate hike process back at the end of December 2015. Between December 2015 and June 2017, the Fed hiked its key interest rate four times. In June 2017, other central banks—such as the European Central Bank (or ECB), the Bank of England (or BoE), and the Bank of Canada (or BoC)—indicated a hawkish stance in the near future.

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Correlation between the S&P 500 index and Fed’s rate hike

The SPDR S&P 500 index (SPY) rose nearly 0.75% between June 15, 2017, and July 13, 2017—nearly a month’s performance after the hawkish statements provided by major central banks. Between December 2015 and June 2017, the S&P 500 index (IWM)(VOO) rose nearly 19%. The rally in the S&P 500 index was mainly driven by the optimistic view on the US economy after the US election outcome on November 9, 2016.

However, the correlation between the S&P 500 index and the Fed’s fund rate stood at -43.1% during this period. Since December 2015, the Fed has started its gradual rate hike process.

The correlation figure indicates that the movement of the S&P 500 index (VFINX) is somehow negatively correlated to the movement of the Fed’s fund rate. The rate hike could negatively impact the S&P 500 index. Many market participants are also expecting that the gradual rate hike may drag down the S&P 500 index as a gradual rate hike could affect the demand side of the economy.

In the past, we saw that the S&P 500 index reacted negatively to the Fed’s first rate hike in December 2015. The index corrected nearly 12% between December 16, 2015, and February 11, 2016.

In the next part of this series, we’ll analyze how emerging markets (EEM) are reacting to the Fed’s rate hike.


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