By
Derek Hamilton
August 28, 2024
The Federal Reserve (Fed) has been one of the key areas of focus for equity markets over the last few years. Beginning in early 2022, the Fed raised short-term interest rates by more than five percentage points over the following one-and-a-half years. So far, the economy has not seen a significant impact from those rate hikes. Following the equity market selloff in 2022, markets have skyrocketed despite higher interest rates.
Changes in monetary policy typically impact the economy with long and variable lags, as observed by economist Milton Friedman. In other words, it usually takes time for interest rate changes to impact economic growth, something that might hold true for equity markets as well. Today’s chart looks at the relationship between the federal funds rate and the CBOE Volatility Index® (VIX®), which measures the expected volatility of the US stock market. Every time the Fed has significantly raised interest rates, the VIX has jumped roughly two years later. We are now at that point when the Fed’s rate hikes could start affecting markets.
With inflation moving lower and unemployment beginning to rise, the Fed has signaled rate cuts may come soon. Will it be enough to prevent the long and variable lags from impacting markets? Maybe this time is different, and the tremendous amount of government stimulus coupled with the artificial intelligence revolution has buttressed equity markets. Only time will tell, but the clock is ticking.
Federal funds rate and the CBOE Volatility Index (VIX)
Sources: Macquarie, Macrobond, Federal Reserve, Chicago Board Options Exchange (CBOE).
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