How do Rate Hikes Affect the Stock Market?

As the inflation fear looms, investors are keeping an eye on FED’s decision on rate policy. 

Why Do Investors Care So Mush About the FED's Decision on Rate Policy?

Assets such as stock are evaluated based on the "risk free rate". If the risk free rate increases, stock values should fall if all other conditions remain the same. The stock prices should rise if the risk free rate falls.

One simple explanation of the above situation is that if the risk free rate rises, people would find it more attractive to invest in bonds not stocks therefore sell stocks to buy bonds, which would cause stock prices to fall.

Suggested reading: Two Examples of "Interest Rates Rise, Assets' Values Fall"

How Did Stock Market React to the Rate Hikes in 2016?

By the end of 2015, the FED has started a series of rate hikes because the economy had come back from the 2008 financial crises. 

At the beginning of the rate hikes, stocks did tumble a little bit then gradually rose afterwards.

One Possible Reason that the Stock Market would Keep Rising During Rate Hikes

One key reason why the FED raises the target rate is inflation. If inflation is too high, which means people are spending money and companies are investing too much, the FED would consider raise the target rate, causing it more expensive to borrow and more lucrative to save, which lowers people and companies' spending, then lower inflation.

While people and companies are spending a lot and causing inflation, they are helping the economy to grow. When the economy is growing, the stock market would follow.

In other word, money were well spent during times of low interest rates from 2008 to 2016.

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Data source: macrotrends. www.macrotrends.net. Accessed July 17 2021.