If the Federal Reserve Hikes Interest Rates in 2026, History Has Good and Bad News for Investors

Interest rates are the primary tool that the Federal Reserve uses to calm or jump-start the economy. When it cuts its benchmark rates, markets usually rise, as lower costs to borrow spur companies to invest, transact, and acquire. That, in turn, leads to economic growth and, typically, rising stock prices. That's the good news.

When the Fed raises rates, though, markets tend to react negatively, because when the costs of borrowing go up, it increases expenses, drags on earnings, and can deter companies from making investments. That's the bad news.

But it's never that simple.

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A rate hike is expected in 2026

The benchmark federal funds rate had been close to 0% for six years after the Great Recession, from 2010 to the end of 2015, as the economy recovered. But in the rate-hiking cycle that followed, it never went over the 2.25% to 2.50% range, peaking in July 2019. Four raises in 2018 were a major reason that the S&P 500 was down 4% in 2018, but it surged 31% in 2019 when the Fed began lowering rates.

The COVID pandemic hit in March 2020, and the Fed flattened interest rates back to 0% again to support the economy through that turbulent period. This helped spur another rally as the S&P 500 returned 18% in 2020 and 29% in 2021. Inflation started rising due to a combination of low rates, supply chain issues, and economic stimulus, among other factors, so the Fed went on an aggressive rate-hiking spree starting in April 2022 through September 2023 that brought rates from 0% to the 5.25% to 5.50% range, where they peaked and remained until August 2024. In 2022, the S&P dropped 19% and the Nasdaq fell 33%.

The simple fact that the rate-hiking phase of that cycle appeared to be over fueled a rally in 2023 -- the S&P soared 25%.

The Fed's rate-cutting cycle began in September 2024 and continued until December 2025. Markets continued to rise in 2024 and 2025, as rates fell to the 3.50% to 3.75% range. Consequently, the S&P 500 was up 25% in 2024 and 18% in 2025.

But since then, rates have plateaued, remaining at the 3.50% to 3.75% range. Markets had been expecting further cuts in 2026, possibly two 25-basis point reductions, but tariffs, rising inflation, geopolitical conflicts, and a slowing economy have changed that view. As a result, markets have been more volatile, although they are still up 12% year-to-date.

Now expectations have flipped, and a rate hike is expected this year, according to CME's FedWatch. This poll of interest rate traders finds that 51% expect a rate hike in October, while 70% expect rates to be higher by December.

A hike is already baked in

It is by no means a foregone conclusion that rates will go up this year, and even if they do, this is a new cycle. The two most recent rate-hiking cycles started from the bottom -- at or near zero. This one would be starting from the middle, and it seems unlikely that those increases would be the start of an extended cycle of hikes, given the Fed's own summary of projections.

The Federal Open Market Committee anticipates one hike in 2026, but then forecasts rate cuts in 2027 and 2028 with a longer-run target of 3% to 3.25%. Again, this is how they see it now. Their views could change.

So, I think it's hard to draw any solid conclusions on how the market may react to a single rate hike later this year. It is already expected and may already be baked into investors' thinking, which would mean it would have little impact on the market when it arrives -- assuming that it does.

Now, if there are multiple rate hikes, that might be a different story. But the Fed isn't anticipating that, and neither are most investors. I think a single rate hike this fall could be a non-event. And longer term, if rates trend lower, that would likely have a positive effect on the market.

It is always important to keep a long-term mindset as an investor, because even if markets jolt lower after successive rate hikes, things have a way of resetting as companies adjust to the new reality, and stocks generally move higher over the longer term.

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