It’s coming.

Market participants are expecting the third Fed rate hike since December 2015 at next week’s FOMC meeting. This is a move up in expectations from the start the year when market participants were saying no hike would occur until June.

The Fed Funds Effective Rate is now at its highest level since 2008, and will push higher again if the Fed meets market expectations.

3-Month Treasury yields are at 8-year highs ahead of the meeting, already discounting another hike.

(Click on image to enlarge)

With rates on the short end rising at long last, there is much speculation from pundits on the supposed impact on markets. If you listen to the pundits, they will tell you that the impact will be negative. They have been saying so since the first rate hike in December 2015.

And since that first hike, the S&P 500 (total return) is up over 19%, hitting 46 new all-time closing highs. If you thought that fact would silence the pundits, you would be wrong. They are out again saying the March hike will lead to a collapse.

Which begs the question: is a sharp move higher in the Fed Funds rate a reliable warning sign of an imminent collapse?

Not exactly.

Going back to 1954, the largest (top decile) moves higher in the Fed Funds rate over a 1 to 5 year period were all followed by positive returns on average over the subsequent 1 to 5 years.

It is true that these returns were typically below average in the 1-3 year forward time frame, and certainly below the periods following times when rates were moving lower, but they were still positive.

In terms of the percentage of positive returns, we find a similar result. Large moves higher in the Effective Fed Funds rate tends to be followed by lower odds of a positive return, but the odds are still above 50% in all periods.

Now, it is important to keep in mind that the move higher in the Effective Funds Rate today is nowhere near the top decile. To qualify for the top decile over a one year period, the effective Fed Funds Rate would have to rise by at least 2.2%. Even if the Fed hiked 3 times this year it would only be a 1% year-over-year move.

Looking at the historical data, the forward returns following such a move (around 1% YoY) are not much different from the average in all time periods.

None of this data suggests that the market can’t go down if the Fed hikes in March. It certainly can. It’s just that one cannot make such a prediction based on the Fed Funds rate alone. All else equal, a Fed Funds rate moving sharply lower appears to be more favorable than one moving sharply higher, but that is not nearly the same thing as saying cuts are positive while hikes are negative. The data does not support such a conclusion – not even close. In any case, rates are not moving sharply higher today but at a very modest pace.

As I argued last year (see “the easy money game has changed”), the irony is that market participants should actually be hoping the Fed continues to hike rates because it will mean new all-time highs in markets, benign credit conditions, and a continued economic expansion. Even with a hike to 75 to 100 basis points next week, the Fed will be extraordinarily easy given core inflation of 2.3% and an economy that has added jobs for a record 76 consecutive months.

Regardless of what the stock market does thereafter, a hike next week is warranted and a welcome sign. If you want to fear something related to the Fed, fear the scenario where they cut rates this year, for that would likely mean a highly turbulent stock market and/or severe economic weakness.