A first-ever Fed September interest-rate hike could set stocks reeling Wednesday

With the Federal Reserve all but certain to raise interest rates on Wednesday, investors may need to brace for sudden, unexpected market volatility as stocks have been underperforming on Fed Days in recent months.

Data published by Bespoke Investment Group Tuesday indicate that stocks, on average, fell 0.13% on the last 10 times the central bank held its policy meetings.

Adding to potential trouble, George Goncalves, head of U.S. rates strategy at Nomura, notes that a Wednesday rate hike would mark the first time that the Fed has tightened in September, a month in which the stock market historically has not performed well.

Longer-term, stocks have done well on Fed Days with the S&P 500 rising an average of 0.28% since 1994 versus the average 0.03% for all trading days. Not surprisingly, the market tends to get an extra lift when the Fed cuts rates, logging gains of 0.44%, compared with 0.25% when it tightens monetary policy, according to Justin Walters, strategist and co-founder of Bespoke, in a note to clients.

Bespoke Investment Group

But the market’s relative strength on Fed Day has been put in doubt recently with the S&P 500 finishing in the red the last three times the Fed has hiked rates.

“The S&P 500 has now fallen on four consecutive Fed Days dating back to March. The biggest decline on the last four Fed Days was just 0.72% on May 2nd, though, so at least the drops haven’t been extreme,” said Walters.

Nonetheless, the large-cap index dropping for four Fed Days in a row is not that common and has only happened twice since 1994 — in September 1996 and September 2002.

There also appears to be a certain pattern to how the day unfolds.

As illustrated in the chart below, the S&P 500 kicks off on a positive note and then starts losing steam into the afternoon.

Bespoke Investment Group

“After a drift lower from noon to 1:30 p.m. Eastern, we’ve seen the S&P catch a bid into the 2 p.m. rate announcement. From 2 p.m. to the close, however, we’ve seen the equity market sell off pretty sharply to take the index into the red by 20 plus basis points by the close of trading,” writes Walters.

Beyond Fed Day, stocks tend to decline in the first month following a rate hike with the large-cap benchmark shedding an average 0.41%.

Bespoke Investment Group

One positive factor working in favor of stocks, however, is that the S&P 500

SPX, -0.13%

  and the Dow Jones Industrial Average

DJIA, -0.26%

 are both up this month despite September’s dismal record for returns.

The CME FedWatch website puts the probability of the Fed raising the federal-funds rate by 25 basis points to a range of 2% to 2.25% on Wednesday at 94.4%.

The yield on the benchmark 10-year Treasury

TMUBMUSD10Y, +0.24%

 has recently moved back above 3% to trade at 3.09% as the economy continues to expand at a healthy pace.

The Fed has strongly hinted at four interest-rate hikes this year or one each quarter, with the markets anticipating another increase in December. Investors are expected to closely review the monetary policy statement for insights into what policy makers think of the economy and trade tensions, with economists suggesting the Fed will signal its commitment to a tighter regime by dropping references to “accommodative.”

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