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This is a guest post by Wayne Whaley (CTA):
Although we are programmed to believe that higher rates are bad for equities, I have done research over the past 6 months that suggest that when rates are very low, the initial signs of rate increase are not necessarily negative for the market. For details, see: What Do Rates Rising from Zero Mean for Equities?
I found two sites that had discount rate history. The first was the New York Fed, with the data range 1970 to today. And the other was from Harp Financial with the data range from 1945 to 1970. The second source is questionable since some of their dates did not exactly match up to those on the Fed Bank site. If someone has a better Discount Rate database, please let me know.
I looked at all times when the Fed Discount Rate was low (less that 5.0) and raised for the first time reversing a policy of declines. Here are my preliminary findings:
Twelve months later, the S&P was positive 7 out of 8 occasions with an average gain of 9.40%. The old adage is “Three steps and a stumble”. I think there is some wisdom to that philosophy and even more so, if rates are extremely low. The announcement today, caught everyone off guard and may have a 1-3 day impact on the market. But I believe, it may end up being constructive that everyone had the evening to do their homework and reevaluate before over reacting.
Also, it went largely unnoticed, but the January 2010 LEI came out yesterday and provided the tenth consecutive monthly increase. It is time for the Fed to work its way out of crisis mode (rates below 1%) to a simply very accommodative mode 1-2%.
For more on the effect of interest rates on the stock market: The Interest Rate Myth - A Bullish Argument
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