Is the Market Underestimating the Risk of a Hawkish Fed Surprise?

In an anticipated event for global markets, the U.S. Federal Reserve’s Open Market Committee is scheduled to convene on September 16-17. The current market positioning reflects a high expectation of a 25-basis-point rate cut among analysts.

While the market appears to be pricing in this specific outcome, a deeper look into historical trends reveals a fascinating pattern: the Federal Reserve has, on occasion, delivered policy surprises that defy common expectations. Should the committee choose to maintain the current rate, this unexpected decision could serve as a catalyst for significant market volatility. Our analysis of historical precedents indicates such an event could lead to a market decline of up to 8%.

But for investors seeking potential growth with reduced exposure to the high volatility of individual equities, we invite you to consider the High Quality Portfolio. Since its inception, this portfolio has demonstrated a remarkable track record, consistently outperforming its benchmark—a blend of the S&P 500, Russell, and S&P MidCap indexes—and generating cumulative returns exceeding 91%. Separately, see – GOOG Stock To $400?

Image by Horst Schwalm from Pixabay

Relevant Articles

1. What’s Behind SoFi Stock’s 101% Surge?
2. Why Has Newmont Stock Surged 135%?
3. Why Did Okta Stock Drop 20%?
4. Salesforce’s Pivot: Why “Agentforce” Matters More Than the Earnings Beat
5. RBRK Stock Analysis: Strong Growth Meets Rich Valuation
6. Why Zscaler’s 27% Crash Is the Ultimate Test for Software Investors

---

The Fed’s History of Crushing Market Expectations

Recent history demonstrates that when the Federal Reserve’s policy announcements have been more hawkish than anticipated, the S&P 500 has experienced notable corrections. The S&P 500 levels noted below are as of the trading day immediately preceding the start of each FOMC meeting, providing a clear baseline for the market’s reaction.

• September 20-21, 2022: In response to persistent inflation, the Fed’s aggressive stance triggered an 8% decline in the S&P 500, which fell from 3,900 on September 19 to 3,586 by September 30. This represents the most severe market reaction in the observed period.
• December 12-14, 2022: The market had priced in a potential policy pivot, with the S&P 500 at 3,991. When the Fed did not signal a shift towards easing, the index fell 4.6% to 3,808 by January 5, 2023.
• July 25-27, 2023: Despite a period of relative market calm, the Fed’s continued hawkish messaging led to a 4.1% market decline, with the S&P 500 falling from 4,567 to 4,380 by August 18.
• December 16-18, 2024: Although the Fed implemented an expected rate cut, its hawkish forward guidance prompted a 3.9% selloff. The S&P 500 declined from 6,074 to 5,836 by January 13, 2025.

Across these instances, the average market decline following a hawkish surprise from the Fed has been approximately 5%.

Current Market Vulnerabilities

The present market environment may be particularly susceptible to a policy disappointment due to several factors:

• High Valuations: Elevated S&P 500 trading levels could exacerbate the impact of any negative surprises. Wondering how bad things can go? Our dashboard – How Low Can Stocks Go During A Market Crash – captures how key stocks fared during and after the last seven market crashes.
• Investor Expectations: Widespread anticipation of rate cuts has created a market sensitive to any deviation from this consensus.
• Asset Positioning: Significant institutional investment in duration-sensitive assets could amplify selling pressure if rate expectations shift.

Potential Scenarios

Two primary scenarios can be considered based on historical data:

• Base Case Scenario: A modest surprise, such as the Fed maintaining current rates when a 25-basis-point cut is expected, could lead to a correction in line with the historical average of approximately 5%.
• Stress Case Scenario: If the Fed not only forgoes a rate cut but also maintains a hawkish tone, a more severe market reaction could occur, potentially approaching or even exceeding the 8% maximum decline observed in September 2022.

Given these historical patterns, investors may consider positioning for potential volatility. Strategies could include focusing on sectors that may benefit from higher-than-expected rates, such as financials, and utilizing options to hedge against downside risk. The consistent market corrections following Fed policy disappointments since 2022 underscore the importance of risk management in the current environment. For instance, the Trefis High Quality portfolio has managed to outperform the S&P 500 while avoiding much of this Fed-induced carnage, delivering cumulative returns of over 91% since inception—a stark contrast to the wild ride of broad market indices.

Invest with Trefis Market-Beating Portfolios
See all Trefis Price Estimates