How Interest Rate Hikes Affect the Stock Market [+ How to Profit]

This guide explains how interest rates impact the stock market, why the Fed is hiking rates, and how traders profit despite rising interest rates.

Connor Kimball
Head of Operations

On March 14, 2022, the Federal Reserve did something that hadn't been done in two years. For the first time since March 2020, it raised the Federal Funds Rate, what most people call "interest rates," above 0.1%, all the way to 0.33%.

By June 13, the Fed raised interest rates to 1.58%, and then to 4.33% before 2023. The Fed's most recent rate hike in August brought the interest rate to 5.33%, the highest federal funds rate the stock market has seen in 20 years.

Federal Funds Rate 20Y Chart

This article is an extension of my Q&A with Dutch Masters, where I asked the man behind the trading desk:
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How do rising interest rate affect stock prices?
Why is the Fed hiking interest rates, and will they do it again in 2023?
How do stock traders profit while interest rates rise? Examples included.

Table of Contents

How Interest Rate Hikes Affect the Stock Market

Key Points

Interest rates have an inverse relationship with the stock market. When interest rates rise, share prices fall.
How the Fed manages interest rates is the most important macroeconomic signal that swing traders should monitor.
Stock traders can still be profitable during rate hikes, high inflation, and recessions.

Recent Impact of Interest Rate Hikes on the Stock Market

How has the market reacted to recent hikes in the federal funds rate?

correlation-between-s&p500-and-interest-rates

Dutch Explains The Relationship Between Interest Rate Hikes & the Stock Market

Transcript

Dutch, why are interest rates (Federal Funds Rate) so important to the stock market?

Well, 1st of all, we have to understand that the Fed is in charge of basically moderating our economy, making sure that there's full employment and making sure that inflation is under control. So The Fed raises and lowers interest rates kind of as a means of doing that and achieving that job. So the Fed, raising interest rates is trying to slow down the economy, because when you have really low interest rates, lots of people borrow, companies borrow, people borrow, borrow, consumers borrow.

Low interest rates means that there's a flood of activity. Purchasing uh because things are more reasonable there's not as high interest rate to pay. When they're raising rates, they're trying to pull that back and slow the economy down. When you have a slowing economy, less people are remodeling their homes, for example.

Right now, Home Depot just came out and said, we don't have as many people renovating their homes because interest rates are high. So when interest rates were low two years ago, three years ago, two and a half years ago in 2020 everybody was remodeling your house because you could borrow at two percent or whatever and that's almost nothing, right? So you're gonna borrow money and you're gonna go put in a new bathroom and a new kitchen and then put an addition on your house uh when rates are seven eight nine percent which is what it would cost you to borrow that same money today just three years later that starts to get expensive. People say "I'm not going to pay that," so then not as much activity at home depot.

Home Depot has seen their sales fall for the last three quarters in a row and eventually that hits their earnings and the stock goes down that's how interest rates affect the stock market.

Why the Fed Hikes Interest Rates (Inflation)

Key Points

Higher interest rates mean lower inflation rates. Hiking interest rates is the fastest way for the Fed to reduce inflation rates.
The US inflation rate nearly quadrupled in 2021 and doubled again in 2022.
The Fed would rather risk a bad stock market than let inflation rates continue rising.

If hiking interest rates slows down the economy and causes stock prices to fall, why does the Fed hike rates in the first place? The answer is inflation rates, and the problem is how fast they are rising.

interest-rate-hike-cut-affect-on-inflation

Raising Interest Rates Reduces Inflation Rates

Normally, the Fed would wait until the economy is stronger before raising rates. But 2023’s recent rate hikes are motivated by rising inflation rates in 2021 and 2022.

Year	Inflation Rate	% Change from Previous Year
2019	1.81%	-25%
2020	1.23%	-32%
2021	4.70%	282%
2022	8.00%	70%

2022 is the first time since the 1960s interest rates exceeded 5% for reasons unrelated to war or oil.

Yikes! This chart makes it easy to see why the Federal Reserve wants to get rising inflation rates under control as fast as possible...

Dutch Explains Inflation & Interest Rates

Transcript

If interest rate hikes slow down stock markets, why is the Fed still hiking rates?

Well, because inflation is worse. It’s evil that you can buy you can buy a house for two $250,000 today if there's inflation that exact same house is going to cost you in four or five six years $450,000 because the price is inflated. House has not become worth more, it's that the number of dollars that it takes to buy that same house is more because that dollar is worth less. There was a time when you could buy a gallon of milk for a $1.50. That gallon of milk is now four fifty or six fifty for a gallon of milk and it's not because that milk is like much more precious and that there is not not as much of it to make it go up in value.

There was a time when you could buy a gallon of milk for a $1.50. That gallon of milk is now four fifty or six fifty for a gallon of milk and it's not because that milk is like much more precious and that there is not not as much of it to make it go up in value.

It's that the dollar that you have to use to buy it, is worth less, so you have to use more dollars. The reason that you would do that is you don't want high inflation because it makes the dollar less valuable, much faster. So they try to keep inflation at about a two percent a year rate when you start to see inflation tick up three four five six seven eight nine we had ten nine ten eleven twelve percent inflation, because of the pandemic and all the money that they shoved into the system.

And so prices went skyrocketing. A lot of things went up in value or a lot of things went up in terms of their cost. The dollar got crushed. They're really, they're trying to get that under control as we speak, and they're doing a pretty good job of it. But you know, you could buy a house with a two or two and 5 % mortgage. Three years ago and now you have to have a seven eight or even an eight and a half percent mortgage on it.

How Stock Traders Profit Despite Rising Interest Rates

Key Points

As share prices fall, swimming with the tide of the market is a losing game.
Traders stay profitable by betting against the market with inverse ETFs. This is called “shorting the market.”
Inverse ETFs are the stocks to buy when interest rates rise as fast as this.

As swing traders, we aren’t content with fully defensive strategies or sitting on the sidelines for too long. We want to trade and make money this month, no matter how bad interest rate hikes are.

Inverse ETFs are the best way for active traders to make money while interest rates rise. Inverse ETFs allow you to…

How powerful are inverse ETFs in a bad market? While the S&P fell 18% in 2022, Carnivore Trading’s portfolio was up 321%! All thanks to our shorts, which are possible with a tool like the inverse ETF.

Inverse ETFs

An inverse exchange-traded fund is an exchange-traded fund (ETF), traded on a public stock market, which is designed to perform as the inverse of whatever index or benchmark it is designed to track. These funds work by using short selling, trading derivatives such as futures contracts, and other leveraged investment techniques.

An inverse ETF has the same practical effect of short selling the stock market. For example, an inverse S&P 500 ETF, will move opposite of the S&P each day. If the S&P 500 rises by 1%, the inverse ETF will fall by 1%, and vice-versa. This makes them a popular investment during bear markets.

Inverse ETF Examples (Profiting in a Bear Market)

2022 was a rough market, no question. Despite that, Carnivore Trading has its most profitable annual performance in history. That was only possible thanks to inverse ETFs.

Here are our best inverse ETF sales from last year.

Dutch Explains How Stock Traders Profit While Interest Rates Rise

Transcript

As stock traders, how do we still profit while interest rates rise? Are there types of stocks to buy?

That's a great question. And what happens is if you have rates going up, it makes it very difficult to make money in bonds because bonds actually go down in value. They, they are an inverse. To interest rates as interest rates go up bond value goes down so the bond that you bought at a thousand dollars per bond is worth nine hundred dollars and then eight hundred dollars and then seven hundred dollars and we've already seen that happen in this last interest rate increase period you know you can actually bet against the stock market during a rise in interest rates because you know people start to get worried about earnings being hurt and companies not doing as much in sales. So one way to do that is an inverse ETF so let's say for example you don't like the dow jones you think that the stocks in the DOW are going to fall you can actually buy an ETF in your account your ir account or a regular account you can buy an ETF that goes up in value if the dow falls so that's a that's a tool in the toolbox that we use it's also a tool in the toolbox that your father didn't have okay that didn't exist as a vehicle to make money when the markets are falling.

20 years ago they didn't exist. What a fantastic development. Now the regular guy at a Commission House can No commission brokerage firm can purchase something that goes up in value when the market falls. I mean, they've been around now for 20 years. They work. They're a tool in the tool belt we use it but for some reason lots and lots of people still don't know about them they still don't use them. Your financial advisor doesn't want you to know about them, your financial advisor doesn't want to talk to you about them, and many financial advisors are sitting there saying "oh no, we're not even allowed to let you buy this."

Well in 2020, when the stock market got destroyed and the bond market got destroyed, I mean the worst market for stocks and bonds in my lifetime, Carnivore Trading was up three 321%. We used those two tools. People who weren't using those tools, the only thing you could do is sit in cash on the sideline or try to make money in some stocks. The only stocks that really went up in 2020 were oil stocks and that was a rocky ride, not a straight line. There are tools you can use in down markets, there are tools that, there are things that you can, that you can buy, but in terms of making money in the stock market during a rising interest rate environment, it's very, very tough.

Sometimes real estate oriented stuff will do well, but that's hit and miss.

Will the Fed Continue Hiking Rates in 2023?

Key Points

The Fed is unlikely to hike rates again in 2023. Unless inflation rates remain high.
The Fed wants an inflation rate around 2%. 2022's inflation rate was 8%.

So, what’s the Fed going to do with interest rates next? Are more rate hikes coming, or will we settle down for awhile and see what inflation rates do? Dutch and Trader Z discussed this on a recent *APEX call.

On the call, Dutch questioned Goldman Sachs' prediction that the Fed will lower interest rates this year, citing rising oil and gas prices and food costs. He agrees with Trader Z's thoughts about where the Fed wants inflation rates at.

Trader Z is not expecting higher rates this year, but that could change if the inflation rate doesn’t drop to 2% or below this year. It is highly unlikely that the Fed lowers interest rates in 2023.

Trader Z also mused about the general populations' misplaced expectations about inflation. Many young people think that prices will eventually come back down, but this will be an exception, not a rule.

*APEX is our premium service designed for money managers and retail traders playing with over $100K in their account. For those new to Carnivore, we recommend a 14 day free trial of our Swing Trade Alert Service →

Watch Dutch Masters Discuss Interest Rate Hikes, Inflation, and How to Profit While Interest Rates Rise

Watch my full interview with Dutch, where he answered:

Why are interest rate hikes so impactful to the stock market?
If raising interest rates slows down the economy, why would the Fed keep increasing them?
How can stock traders continue to profit while interest rates rise?

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