How Will the Market React to a Potential Fed Rate Hike in December? Here's What History Suggests.

The Federal Reserve is widely expected to raise interest rates at its Dec. 9 meeting. CME FedWatch data indicated an 86.8% probability of a 25-basis-point (one-quarter of a percentage point) hike to 4%–4.25% and a 13.2% probability of a 50-basis-point (half percentage point) hike to 4.25%–4.50% during trading on Nov. 11.

Investors have already started reacting to changing rate expectations. After October inflation exceeded expectations, the two-year Treasury yield jumped about 18 basis points on Nov. 10. The S&P 500 (SNPINDEX: ^GSPC) fell 0.38% on that day. However, the large-cap stock index rebounded 1.3% on Nov. 11, helped by a rally in artificial intelligence (AI) stocks.

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History shows that stocks do not always fall after rate hikes. The market's response also depends on what investors expect from the Fed's future interest rate decisions.

Similar hikes, different market reactions

On Dec. 16, 2015, the Federal Reserve raised interest rates by 25 basis points for the first time in nearly a decade. The S&P 500 gained 1.45% that day. Investors had anticipated the increase, and the Federal Reserve indicated that subsequent hikes would be gradual.

On Dec. 19, 2018, another 25-basis-points interest rate hike coincided with a 1.54% decline in the S&P 500. Investors were worried about slowing economic growth, while the Federal Reserve still projected additional interest rate increases. Federal Reserve Chairman Jerome Powell also indicated that the central bank would continue reducing its bond holdings, a policy that withdraws liquidity from the financial system. This added to investors' concerns about tighter financial conditions.

However, the S&P 500 gained nearly 28% over the following 12 months, during which the Federal Reserve reversed course and cut interest rates three times in 2019.

The interest rate hike in March 2022 offers another example. The S&P 500 gained 2.24% on March 16, when the Federal Reserve began raising interest rates. However, the S&P 500 index lost 9.1% over the following 12 months, as inflation remained high and the central bank accelerated rate increases. The Russia-Ukraine war, slowing global growth, and recession fears also weighed on stocks.

These examples show why the market's immediate reaction to a rate hike does not necessarily indicate how stocks will perform over the following year.

The Federal Reserve's next signals may matter more

A widely expected 25-basis-point hike in December may have a limited impact on stocks. However, a surprise 50-basis-point increase or signals of more rate hikes in 2027 could push Treasury yields higher and negatively impact stock prices.

In September 2026, Federal Reserve officials projected a median interest rate of approximately 4.1% at the end of both 2026 and 2027. The new projections in December 2026 could indicate whether policymakers now expect more increases. Higher interest rates can raise companies' borrowing costs and reduce what investors are willing to pay for their future earnings.

The pace of interest rate increases is also important. A Charles Schwab report examined 18 Federal Reserve tightening cycles since World War II. The S&P 500's average maximum 12-month decline following the first hike was 16% in faster-tightening cycles, compared with 12% in slower ones. These numbers measure the largest declines during those periods, not full-year returns.

Some stocks may perform better than others

The U.S. economy has remained resilient. Inflation-adjusted gross domestic product (GDP) grew at a 3.4% annualized rate in the third quarter. Employers also added 165,000 jobs in October 2026. Continued economic growth could help companies sustain sales and earnings despite higher interest rates.

However, not all businesses can manage tight financial conditions. The Federal Reserve's May 2026 Financial Stability Report found that many publicly traded companies remained well positioned to service their debt. However, some riskier borrowers with floating-rate loans faced greater debt-servicing pressures.

Stocks trading at premium valuations may face downward pressure if investors are not willing to pay a premium for future growth. Instead, companies with strong cash flow and reasonable valuations may be better positioned to withstand further rate increases.

What should long-term investors do?

Investors hoping to avoid potential losses from a December rate hike may consider selling stocks before the Federal Reserve's announcement and buying them again at lower prices. However, this strategy requires accurately predicting when stocks will decline and when they will recover. Morningstar found that between January 1990 and March 2026, the median gap between the S&P 500's 10 worst and 10 best trading days was just seven days.

Historical returns also suggest that rate hikes do not necessarily lead to prolonged stock market declines. LPL Research examined six Fed tightening cycles since 1994 and found that the S&P 500 gained an average 6.7% in the 12 months following the first hike. However, the absolute returns varied across the different time periods.

A widely expected December rate hike may affect stocks, but unexpected signals about future increases could trigger volatility. Long-term investors may be better served by maintaining diversified portfolios and focusing on companies' financial health rather than trying to predict the market's immediate reaction.

Manali Pradhan, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.