The Fed Hiked. The Bigger Story Is Productivity

What the Fed actually did

On 16 September, the Federal Reserve raised its policy-rate target by a quarter point to 3.75%–4.00%. Its statement also described economic activity as expanding at a solid pace. Both facts matter: the rate decision alone says little about what comes next for shares.

The August consumer price index was 3.4% above a year earlier, according to the Bureau of Labor Statistics. That is an inflation problem, but the size and source of the problem matter when comparing cycles.

History is a useful check, not a forecast

In 2022, inflation reached 9.1% in June, the Fed tightened rapidly and the S&P 500’s calendar-year price return was about −19.4%. The combination compressed valuations and raised recession fears. It does not follow that every hike creates the same result.

During the 2004–06 tightening cycle, the Fed moved from 1% to 5.25%; the S&P 500 delivered positive total returns in each of those three calendar years. The 1994 tightening year also finished slightly positive. Those examples establish possibility, not probability. Starting valuations, earnings growth and inflation differ across cycles.

Inflation sorts companies

Nominal revenue often rises with prices, but higher sales do not guarantee higher real profits. A firm benefits only if it can pass through costs without losing too much volume. Energy producers and owners of scarce real assets can gain when the price of what they sell rises faster than their costs. Companies with fixed-price contracts, labour-intensive operations or weak brands may see margins squeezed.

Bondholders face a distinct problem: inflation erodes the real value of fixed coupons, while rising yields reduce the market value of existing bonds. Duration determines how severe that price decline can be. Equity investors face a different mix of effects across sectors and business models.

The productivity test

The constructive case is strongest if output per hour rises, letting companies grow without equally rapid increases in wages and prices. We would watch real earnings growth, unit labour costs, margins and productivity data together. A stock market rising only because investors pay more for the same earnings is less resilient to higher rates.