To this point, investors are somewhat caught in the middle, buoyed by solid economic and earnings data, but anxious about the direction of interest rates. Much of their focus is on Federal Reserve (Fed) interest rate policy. After the Fed triggered 11 increases in the short-term federal funds target rate it controls, it signaled its intentions to cut rates in 2024. However, Fed officials also indicated that more convincing evidence that inflation is under control is required before it makes its first rate cut.2
How are interest rates likely to impact the stock market over the course of 2024?
Are interest rates at a peak?
The Fed plays a role in managing key components of the U.S. economy, including moderate inflation, full employment and a modest level of long-term interest rates. In March 2024, inflation over the previous 12 months stood at 3.5%, much lower than its mid-2022 peak of 9.1%, but not yet down to the Fed’s 2% target.3 Fed officials are concerned that inflation has not managed to yet dip below 3%; it has stayed in a range slightly above 3% since mid-2023.
Haworth says markets are anxious to see the Fed’s policy provide an equity market boost. “We now appear to be at a point where further interest rate hikes are off the table, so investors feel they can take some cover from that. They anticipate the Fed’s next move will be to reduce interest rates.” Haworth says the bigger question at this point is the timing of such rate cuts. Recent stock market volatility may be tied to evolving investor speculation about rate cuts’ starting date.
The varied impact of high interest rates
Today’s higher interest rate environment can mean different things to different kinds of companies. “When interest rates first moved higher in 2022, it took its largest toll on stocks with already high valuations,” says Haworth. That included growth-oriented technology stocks that prospered in a low interest rate environment. “In 2023, as interest rates appeared to be approaching peak levels for this cycle, the impact shifted,” says Haworth. “The focus now is on how interest rates impact company finances, and that negatively impacts a different segment of the stock market, namely smaller stocks.” Smaller companies tend to be more dependent on debt issuance. “For many smaller companies, the cost of funding at higher interest rates is a bigger concern than it is for larger companies, which have more cash on hand and often issue longer-term debt,” says Haworth. Markets appeared to recognize this fact. As a result, after underperforming small-cap stocks in 2022, large-cap growth stocks far outpaced small stocks in 2023 and have started 2024 in the same, advantageous position. This chart compares performance of large-cap growth stocks (S&P 500 Growth) and small-cap stocks (Russell 2000 Index).