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Fed fund rates versus SPX

Posted By Barry Ritholtz On December 15, 2004 @ 7:09 am In Economy,Markets | Comments Disabled

From Chart of the Day [1]

The Federal Reserve raised the fed funds rate from 2% to 2.25%.  The charts below provide perspective to the current interest rate environment relative to the stock market. The bottom chart illustrates that while the fed funds rate has been rising as of late, it still remains well within a long-term downtrend. The top chart illustrates how the market performed following significant tops and troughs in the fed funds rate.

Cod_spx_20041215_2 [2]

Cod_fed_rate_20041215b_1 [3]


CoD observes: "The stock market’s performance has been less than stellar following
major troughs in the fed funds rate (see red arrows). There is logic to
this relationship since rising rates increase both the cost of debt and
the relative attractiveness of interest bearing investments."

I would add a few caveats:  First, trend channels tend to work because of Humans buying stocks when they come back to the point they previously missed them at ("if only I bought XYZ when it was at $Z"), or selling them once they get back to a previous higher level (as in "puh-leeze let me get back to break even!").

I’m less convinced charting is as effective at predicting investor behavior when controlled for the Fed.

Second, this is a very long term chart, and timing entries based on a chart that encompasses decades is a bit tricky. The Fed tends to cut after the economy has shown clear signs of slowing or recession. The markets usually get worse from that point on before they get better. The inverse is also true — the fed raises rates when the economy is getting hotter. Stocks tend to do well — until they peak and reverse.

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URLs in this post:

[1] Chart of the Day: http://www.chartoftheday.com/

[2] Image: http://bigpicture.typepad.com/photos/uncategorized/cod_spx_20041215_2.gif

[3] Image: http://bigpicture.typepad.com/photos/uncategorized/cod_fed_rate_20041215b_1.gif

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