Here's what will happen when the Fed cuts interest rates

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Here's what will happen when the Fed cuts interest rates

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Even under Fed rate hikes, stocks usually go up even more if the inflation rate is not hiked in US interest rate.

Rampant inflation in an overheating economy is bad. And so to prevent that or reduce that, the Federal Reserve is expected to tighten its quantitative easing program and increase its Fed funds rate to improve their bond yields.

Currently, the economy is rising and the prices of goods and services are increasing. But it's hard to argue that the economy is still showing trends and has 7.6 million jobs below pre-pandemic levels. It is hard to argue that inflation is pretty limited as the increase in prices appears largely to be unexpected factors like baseline effects, reopening quirks and some related short-term supply chains.

Nevertheless, with the consumer price index jumping a long over - projected 5.0% year-over-year in May — the biggest jump since August 2008 ), it's worth considering what tighter monetary policy could mean for investors.

Jonathan Golub of Credit Suisse did just that earlier this week, and he found that tighter policy isn't obviously bad for stocks as investor could expect.

While investors might interpret the reversal of the Fed policy as a bad omen, history shows that stock returns remain robust in the months leading up to and following the first rate hike, Golub said in a note to clients on Wednesday. More specifically, in the past four rate hike cycles the S&P 500 has gained 9.5% over the 12 months prior to the first hike and 26.0% over the subsequent three years.

The real damage caused by higher rates tends to occur later in the cycle when tighter policy flattens the curve, he added. We are two eons away from this happening.

Now, we'll acknowledge that the average Golub, computed is arguably an oversimplification and that four rate hike cycles is a pretty small sample size.

And when you consider all the other variables in the market, you could also argue that what we have is totally unprecedented today. And so, the past won't help outline the future.

But we can't help but appreciate the stocks usually go up energy, that comes from Golub’s chart. And that is, to put it simply: two points.

First, everyone is already talking about the possible danger of inflation heating up. And so the downside of tighter monetary policy amid rising prices is an event that might already be priced in the market.

Second, businesses can be very flexible in the pursuit of growth in profits. This means that when they come under pressure over challenges that threaten profit growth, they will change their business models or even undoubtedly overhaul their strategies. This is something we have learnt during the coronavirus pandemic. Some offices also had employee working remotely. The restaurants have increased their pick and delivery options. TV personalities from their homes broadcast. And so on.

All this speaks to the truth about stock market. There are always major risks that will make investors nervous about putting money in the market. And there are often big scary shocks that occur with unexpected sell-offs. But even when the things are going better, stocks rally as investors look past the challenges and bet that consumers and businesses will find a way to make things better.

In other words, it's never a given that stocks will fall.

Sam Ro, Senior Editor. Follow him at SamRo?

None 10: 00 am. ET: University of Michigan sentiment, June preliminary judgment.

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