Examining the Impact of the Fed’s Interest Rate Hike on Markets and Profits

As markets anticipate a soft landing and inflation continues to drop, investors are beginning to question the Federal Reserve’s decision to raise interest rates. Despite these indicators, the Fed has remained steadfast in its view that labor market tightness and rising wages pose a continuing challenge to the achievement of its inflation target.[0] This has caused a rally this year, with the S&P 500 and Nasdaq increasing by 5.75% and 10%, respectively, in the first month of 2021.

However, this optimism may be premature.[0] With the Fed signaling “tight for longer,” the risk for second half 2023 corporate profits could be skewed to the downside.[0] Every postwar recession has been accompanied by a fall in corporate profits and a compression of profit margins, and in all recessions since 1970, barring the 1990 downturn, profits recessions have also induced negative equity market returns.[0]

Given this, it is important to consider the implications of the Fed’s decision to raise interest rates. While it may help to combat inflation, it can also lead to a recession by suppressing the business activity that fuels it. Only time will tell what the consequences of the Fed’s actions will be and how it will affect the economy and the stock market this year.

0. “Markets Are Expecting a Miracle from the Fed: A Pivot and a Soft Landing” Barron’s, 13 Feb. 2023, https://www.barrons.com/articles/fed-pivot-rates-markets-soft-landing-b623899a