The Federal Reserve has been on a tear recently by raising the Fed Funds Rate from a target range of 0% - 0.25% in early 2022 to it's current range (as of 5/28/24) of 5.25% - 5.50%. No doubt this has impacted other interest rates such as mortgage rates, credit card rates, and even the rates on corporate and government bonds. But what about the stock market? Is there anything that history can tell us about this relationship? In this post, we will discuss the "relationship" between interest rates and stock prices.
You hear it all the time in the media, “stocks were up today as investors anticipated the Fed will cut interest rates”. But is this the case? Do stocks and interest rates move in opposite directions the way bonds do?
We first want to point out, there is no SINGLE factor that makes stocks go up or down. There is a level of randomness to stock returns, and while our brains want to simply market movements down to one factor, it is just not the case that one thing drives markets.
Now let’s look at the historical evidence in a few different ways. In years with above-median interest rates, since 1955, during which the average three-month Treasury yield was 6.7%, US stocks returned an average of 12.1%. This is slightly higher than the average return in below-median interest rate years (11.6%). This shows that as we get higher interest rates, we also tend to get higher stock market returns, on average.
Next, let’s plot US stock returns vs. Treasury yields to see if we can see a meaningful relationship between the two. The below chart was put together by Dimensional Fund Advisors:
Do you see any patterns here? If so, please let us know what they are because we certainly do not. In this graph we see instances when treasury yields are low and so are stock returns. We also see instances when treasury yields are low and stock returns are high. The data is simply all over the place.
So will higher (or lower) interest rates hurt (or help) stock returns? It’s pretty clear, based on the historical evidence, that interest rate fluctuations won’t necessarily help or hurt the stock market. While it may be one factor that investors consider, it is not THE FACTOR that will drive stock market returns.