How Past Fed Rate Hikes Moved Markets

How Past Fed Rate Hikes Moved Markets

History provides clues for how markets may respond to the coming rate increases.

Senior ETF Analyst
Reviewed by: Sumit Roy
Edited by: Sumit Roy

A rate hike is coming. With only a little more than two weeks until the Federal Reserve's next monetary policy meeting, all signs continue to indicate that the central bank is set to finally increase its benchmark overnight interest rate for the first time in 9 1/2 years.

The only thing that would stop the hike, say analysts, is a surprisingly bad jobs report this Friday. And by bad, they mean really bad.

"...(Y)ou need a number like 50,000 or 75,000 for the Fed not to go in December. There's a low bar for this report to clear," Michael Gapen, Barclays’ chief U.S. economist, told CNBC. That would be well below the 200,000 jobs that most economists are expecting the government to report at the end of the week.

The Hope Of Gradual Rate Hikes

Assuming the jobs report doesn't shock to the downside, the Fed will likely raise the Fed funds rate by 25 basis points on Dec. 17. The Fed has promised that the pace of future rate increases beyond the first will be "gradual."

What a "gradual" pace means is something that Fed officials aren't certain of themselves, but they hope it will be much more restrained than the last rate-hike cycle, which saw the overnight rate lifted for 17-straight meetings under Fed Chairmen Greenspan and Bernanke between June 2004 and June 2006.

That situation of continuous rate hikes is something current Fed officials want to avoid, but if economic growth picks up too much and inflation accelerates, they could find themselves behind the curve and forced to move faster than they now envision.

That would be akin to the February 1994 to February 1995 rate-hike cycle, where the Fed aggressively hiked its benchmark rate from 3% to 6%, surprising markets and leading to intense volatility in financial markets.

Fed Funds Rate

The Last Two Rate-Hike Cycles

The 1994-1995 period and the 2004-2006 period were the last two major rate hike cycles and may offer insight into how markets will respond to the coming moves by the Fed.

The 1994-1995 cycle witnessed much more volatility in stock prices, with the index whipsawing wildly during the year. By the time the Fed stopped raising rates, the S&P 500 was down modestly from where it started the year before. It then surged for the following five years, fueled by the dot-com boom.

S&P 500 Returns Feb. 3, 1994 to Feb. 1, 1995

In contrast, the 2004-2006 rate-hike cycle was a calm period for markets. Stocks marched slowly upward and continued to do so for another year after the Fed stopped hiking rates. Of course, months later, the bursting of the housing bubble and the ensuring financial crisis led to a massive stock market crash.

S&P 500 Returns June 29, 2004 to June 29, 2006

Fed Unlikely To Derail Bull Market

Did the Fed's rate hikes cause the financial crisis? Probably not; though some may argue that the low rates set by the Fed in the early 2000s after the dot-com bubble burst contributed to the housing bubble, which raises the question: Could the low rates of the past several years have unintended consequences for the economy down the line? That remains to be seen.

Regardless, what seems to be clear is that based on the evidence of the past few rate hike cycles, stock markets can withstand higher interest rates. A gradual pace of increases―whatever that may be―is preferable to an aggressive pace of increases, but neither spells the end of the bull market in and of themselves.

Best & Worst Groups

Much like picking stocks, anticipating which asset classes, sectors or groups will do well during the rate-hike cycle is problematic. A few weeks ago, we took a look at the ETFs that in theory should perform the best and worst as the Fed hikes rates, but of course, only time will tell if reality matches up with theory.

During the '94 cycle, ETFs had just been born, with the SPDR S&P 500 (SPY | A-98) making its debut the year before, so there's not much history on them for that time. Even during the 2004 cycle, ETFs were quite young, with barely more than 100 in total in that year compared with more than 1,800 now.

That said, it's possible to go back to those periods and see how various segments of the market performed.

During the 1994-1995 cycle, technology, health care and consumer staples were far and away the best-performing sectors, while consumer discretionary, industrials and utilities were the worst.

In the U.S., small-caps underperformed large-caps, while international stocks struggled, with emerging markets, Asia and Europe all getting hit hard. Bonds declined, but credit spreads didn't widen noticeably. Somewhat counterintuitively, the dollar retreated.

Interestingly, the 2004-2006 cycle saw almost a complete reversal in terms of the stock market groups that outperformed and underperformed. Energy, utilities and materials handily outpaced the broader market, while health care, tech and consumer stocks lagged. Small-caps beat large-caps, and international stocks surged, led by emerging markets. Bonds fell slightly, but delivered solid gains on a total return basis. Once again, credit spreads didn't widen and the dollar sagged.

Contact Sumit Roy at [email protected].

Sumit Roy is the senior ETF analyst for, where he has worked for 13 years. He creates a variety of content for the platform, including news articles, analysis pieces, videos and podcasts.

Before joining, Sumit was the managing editor and commodities analyst for Hard Assets Investor. In those roles, he was responsible for most of the operations of HAI, a website dedicated to education about commodities investing.

Though he still closely follows the commodities beat, Sumit covers a much broader assortment of topics for, with a particular focus on stock and bond exchange-traded funds.

He is the host of’s Talk ETFs, a popular video series that features weekly interviews with thought leaders in the ETF industry. Sumit is also co-host of Exchange Traded Fridays,’s weekly podcast series.

He lives in the San Francisco Bay Area, where he enjoys climbing the city’s steep hills, playing chess and snowboarding in Lake Tahoe.