The Fed's interest rate hike won't necessarily end the bull market frenzy! Historical data reveals: What the market is really afraid of is a “round of austerity”

As far as the bullish trajectory of the global stock market is concerned, it seems that the key risk is not whether the Federal Reserve will return to the interest rate hike policy policy, but rather whether the subsequent Fed's monetary policy path will evolve into a path of continuous interest rate hikes and austerity after the latest rate hike kicks off, and whether higher financing costs will eventually significantly drag down the non-farm payrolls market and corporate profit trajectory. Historical statistics show that in the bear market associated with the economic recession, the median decline in the US stock market reached 36% and continued for 18 months; in the bear market, which was not accompanied by a recession, the decline was 28% and only lasted about eight months.

At least from the perspective of historical data, these data mean that the interest rate path affects the degree of valuation pressure, while economic and profit trends further determine the depth and duration of the decline. After the US PPI data for August, which the supermarket expected, was released, the interest rate futures market's pricing probability of the Fed returning to raising interest rates in September was as high as 70%, and the pricing probability of the October rate hike was over 80%. Most traders (over 50%) are betting that the Fed will return to the path of interest rate hikes before the end of 2026 and are expected to raise interest rates twice.

Energy shocks are increasing the risk of “continuing to raise interest rates after one hike.” The conflict between the US and Iran continues, and the Houthis's advance in Yemen also threatens energy transportation in the Red Sea, putting pressure on alternative export channels. During the Asian market trading session on September 11, although the price of Brent crude oil fell more than 1% to around $105 after news of the easing of the geopolitical situation in the Middle East related to “Iran is about to meet with the six Gulf countries and the Houthis to cease fire on the west coast of the Red Sea” came out, it was close to 110 US dollars per barrel before the easing news was close to 110 US dollars per barrel, a new high of about four months. Using the closing price of Brent crude oil at $72.48 on February 27, the last trading day before the war broke out, the price of Brent crude oil has increased by more than 50% since the war.

Furthermore, the yield on 10-year US Treasury bonds, which have the title of “the anchor of global asset pricing,” rose wildly to 4.979% this week. The US final demand producer price index rose 0.4% month-on-month and 5.4% year-on-year in August — the market-focused year-on-year benchmark was unexpectedly higher than the 5.3% market consensus forecast, which has continued to rise recently, with energy commodity prices rising 4.2% month-on-month. Looking at macroeconomic transmission, continuing high oil prices not only drive up production and transportation costs, but also erode residents' actual purchasing power, which may also lead to increased inflation stickiness and weakening demand.

Oil prices have completely ignited expectations of interest rate hikes, and the global bull market is facing a double test of “interest rate and profit”

The ECB has taken the lead in actively translating this risk of inflation caused by soaring energy prices — for Europe, gas price increases stronger than oil prices — into monetary policy actions. The ECB raised interest rates again by 25 basis points on September 10, raising deposit interest rates to 2.5%, and expects inflation rates of 3.0%, 2.5%, and 2.1% from 2026 to 2028, respectively. Meanwhile, the 2026 economic growth forecast was raised to 0.9%, indicating that policymakers are actively judging that the economy is still capable of withstanding interest rate hikes under the heavy pressure of inflation.

However, interest rate hikes cannot restore blocked oil supply; their main role is to restrain demand and prevent energy price increases from continuing to spread to wages and broader prices; if supply shocks are prolonged, the trade-off between controlling inflation and protecting growth will be more difficult. This is why the ECB still insists on making decisions meeting by meeting and has not promised continuous interest rate hikes in a statement.

Japan is also facing expectations of a faster rate hike. On September 11, some media quoted people familiar with the matter as saying that the Bank of Japan is likely to raise interest rates by 25 basis points to 1.25% next week and is likely to raise interest rates for two consecutive monetary policy meetings; if the September rate hike is implemented, it will be the second time in three months, but the final interest rate level and subsequent pace are still uncertain. The Bank of Japan's policy background includes not only price pressure brought about by energy and exchange rates, but also potential inflation moving closer to target.

Taken together, the world's major developed economies are facing wider austerity pressure, but it is not yet possible to assert that global central banks have simultaneously entered a defined cycle of continuous interest rate hikes: the ECB has acted, and the next steps of the Federal Reserve and the Bank of Japan are yet to be decided, but the market is betting that both the US and Japan will use interest rate hikes to combat rising inflationary pressure and the surge in the bond market yield curve caused by overheating AI investment.

What global stock markets need to test even more is whether profits can offset shrinking valuations. For high-term and high-valuation growth stocks and artificial intelligence computing power infrastructure construction projects that are extremely dependent on external financing, continued high interest rates will increase discount rates and capital costs. If the Federal Reserve enters a new round of real austerity cycles, it will also be a major pressure on the denominator side of the DCF valuation model; for aviation, transportation, and some consumer companies, high energy prices will also directly erode profits. Tracking policy interest rate expectations, actual financing costs, credit spreads, and profit forecasts will become increasingly important for global stock markets.

Furthermore, the fact that unemployment rates in major Western economies are still low is insufficient to rule out the risk of stagflation or even recession in the context of high yields and high inflation. Historically, recessionary bear markets often started before employment data deteriorated significantly. Cash flow ability, balance sheet strength, and cost transfer capacity will therefore become a more important basis for stock selection under this round of interest rate pressure.

One Rate Hike and One Round of Austerity: The Historical Ledger of Bull and Bear Conversions! The bull market is worried about the Fed's interest rate hike cycle, not just one rate hike

Wall Street has a rule about how to end a stock bull market: either the economy turns downward, or the Federal Reserve continues to tighten its policy until something goes wrong. Currently, neither of these situations has occurred, but interest rate risk is quietly returning. According to historical data, a full cycle of interest rate hikes, rather than a single rate hike, threatens bullish forces, and the market usually peaks about eight months before the final new round of interest rate hikes.

On Thursday, the market context changed further. The price of Brent crude oil soared above $105 per barrel on Friday, and was once close to the $110 super mark. US producer price PPI recorded the biggest increase in three months. From Washington to Berlin, global bond yields rose one after another. The probability that the US Federal Reserve will raise interest rates by 25 basis points next week currently included in federal funds rate futures is about 71%.

For the current stock bull market, Wednesday's rate hike itself isn't a cause for concern. Historical data shows that the real threat to bulls is a complete cycle of interest rate hikes rather than a single action.

The chart below compiled by the agency details and accurately sorts out the 12 bear markets where the S&P 500 index fell 20% or more since 1945, as well as four other declines of 18% to 20%, close to the bear market. Among them, six bear markets occurred after a cycle of interest rate hikes, and the economy then fell directly into recession; three occurred after interest rate hikes but were not accompanied by an economic recession; once occurred at the same time as the economic recession during the COVID-19 pandemic; and only two did not raise interest rates or recession. In this comparison, an interest rate hike cycle is defined as a minimum of two rate hikes with a cumulative margin of 100 basis points or more.

In cases involving interest rate hikes, the market usually peaked about eight months before the last rate hike. Therefore, if a series of interest rate hikes begin, historical experience shows that the stock market will not peak when interest rates are first raised.

This rule generally holds true, but there are exceptions. The recessions of 1953 and 1960 did not trigger a bear market at all, while the mild recession of 2001 occurred during the bear market, which had the second-largest decline among these bear markets.

The current market pattern has no historical precedent that fully corresponds. The S&P 500 index is currently about 3% below the record high set in August. The economy has not fallen into recession. The Fed's easing cycle has continued for two years, while the last rate hike occurred more than three years ago.

The closest comparison is in the mid-1990s. After cutting interest rates in 1995, the Federal Reserve raised interest rates separately in 1997 — there was no cycle of interest rate hikes since then, and the bull market continued for another three years. After cutting interest rates again in 1998, the Federal Reserve began a cycle of interest rate hikes in mid-1999. The S&P 500 peaked nine months later, when the internet bubble was at its peak, and then slipped into a bear market associated with the economic recession.

As for the bears' decline, history shows that investors need to look beyond the initial triggers. The interest rate cycle usually lays the groundwork for a decline in the market, but a recession determines the rate of decline.

The bear market associated with the recession had a median decline of 36%, which continued for 18 months, and it would take more than three years to return to its previous high. The bear market, which was not accompanied by a recession, fell 28%, continued for eight months, and returned to a record high within two years. In this sample, all bear markets with a decline of more than 35% fall into the recession-related category. Moreover, the stock market peaked about 10 months ahead of the recession, which means that the bear market driven by the recession began long before the economic downturn became obvious.

As shown in the chart above, interest rate hikes often fall into a certain degree of economic recession, driving the stock market to a deep decline and retracement — a detailed compilation of the S&P 500 index's decline since 1945 broken down by trigger factors. Note: Bear data compiled by Bloomberg includes a retracement close to the magnitude of the bear market.

The seller's agency's view is also broadly similar. Tobias Keller, investment strategist at Yushin Bank, said, “Although the Fed's tightening policy may suppress the market in the short term, and interest rate hikes may also cause phased fluctuations, we still believe that the overall profit environment can provide support.” “As long as the Fed's interest rate hike cycle is generally in line with current expectations, and economic growth and profits remain resilient, investors should be careful not to confuse short-term fluctuations with worsening stock prospects in the medium term.”

This places the labor market, not the Federal Reserve, at the center of the entire analytical framework.

With the exception of the double-dip recession from 1980 to 1982, the unemployment rate was at or near its cyclical low at the beginning of every round of bear markets associated with the recession, between 3.4% and 5.2%. The unemployment rate of 4.1% in August is in this range, but a low unemployment rate does not rule out the possibility of a bear market or recession.

Currently, the exact number of interest rate hike cycles and the extent of austerity are the most important, and the economic context will help determine the extent to which the market will face sell-off or even a new round of bears once weakened.