Event Study: How Do Key Interest Rate Hikes Affect Stock Prices?

By Dimitri Speck of Seasonax.com

Thursday, January 12, 2023 12:27 AM EST

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This is a completely new feature, analogous to the annual seasonality you are familiar with, and which will allow you to improve your investment results even further.

So what are event studies?

I would like to show you what event studies are all about using a simple example of FOMC meetings.

Probably the most important issue for stock market participants last year was high inflation rates, and the increase in key interest rates by the U.S. Federal Reserve to combat inflation.

But how do stock prices behave when key interest rates are raised? Is there an empirical correlation that you can use as an investor?

This is how often the Fed decides on interest rate hikes

Eight times a year, the Federal Open Market Committee (FOMC) of the U.S. Federal Reserve meets to discuss and decide on monetary policy, and the level of key interest rates.

In view of the continuation of high inflation rates, most recently 7.1%, it is generally expected that a further increase in key interest rates will be decided at the upcoming FOMC meeting. The next Fed meeting is scheduled for the turn of this month, January 31 to February.
How do key interest rate hikes affect stock prices?

To answer this question, we will examine the impact on the S&P 500 by looking at the typical course of stock prices before and after the second day of the Fed meeting. This is the day on which the interest rate decision is announced.

The event chart below shows the average course of the S&P 500 in the five trading days before and after the second day of the FOMC meeting.

The chart was calculated over the past 30 years, during which there have been 47 interest rate hikes. The horizontal axis shows the number of days before, and after, the second day of the relevant FOMC meeting. The vertical axis shows the average trend in percent.

The orange line marks the day of the rate hike. In this way you can see at a glance what the typical course of US share prices looks like around key interest rate increases.

Average performance of the S&P 500 five trading days before and after interest rate hikes at FOMC meetings (1992 to 2022)

Prices rise and fall only around the rate hike decision. Source: Seasonax

As you can see, stock prices rise three days in advance of the rate hike announcement (by 0.61% on average).

Then they move slightly downwards for two days.

Only on the third day do they react to the interest rate hikes with a relatively sharp decline.

For you as an equity investor, purchases of stocks are thus statistically more favorable several days before or after the rate hike decision, rather than at the time of the FOMC meeting.

You can use this effect as a trader, but also as a long-term investor, to improve your entry timing.

Furthermore, if you use the event feature of Seasonax in the future, you can select a different number of trading days or a different calculation period. Many event effects last longer than three days. You can also select other instruments such as currencies or commodities and other events such as economic data releases.