The S&P 500 is trading 8% higher today than before the Federal Reserve began its flurry of interest-rate hikes last spring. That’s surprising for a bunch of reasons — but perhaps it shouldn’t be.
The benchmark US stock index closed at 4,720 points on Thursday, compared to 4,358 points on March 16 last year, the day before the Fed began its latest hiking cycle. The US central bank went on to raise its benchmark rate from nearly zero to upwards of 5.25% — a 22-year high — in the space of just over 16 months. It has held rates steady since July.
The Fed hiked in response to a historic spike in inflation. Annualized price growth hit a 40-year high of over 9% last summer, far outpacing the central bank’s 2% target. Higher rates encourage saving over spending and make borrowing more expensive, which tends to temper overall demand in the economy and slow the pace of price increases.
The rate hikes work in part by squeezing consumers, forcing them to allocate more of their monthly incomes toward the bigger payments due on their credit cards, car loans, mortgages, and other debts. American households have also faced soaring food, fuel, and rent costs, which have stretched their budgets even more.
Between inflation in living expenses and higher debt costs, consumers have been left with less disposable income to spend on goods and services produced by companies, hurting sales. Corporations have also seen their costs and interest payments jump, pinching their profit margins.
A company’s shares are generally valued at a multiple to its future earnings, meaning if investors expect its profits to grow less quickly or even shrink, its stock price should come down. Stocks also become relatively less appealing to investors when rates rise, as the returns from safe assets like savings accounts and government bonds increase.
