The Fed Could Be About to Raise Rates for the First Time Since 2023. Here's What History Says Happens to Stocks Next.

Over three years. That's how long it's been since the Federal Reserve last raised the federal funds rate, the interest rate that commercial banks charge each other for overnight borrowing.

This stretch seems likely to end when the Federal Open Market Committee (FOMC) announces the outcome of its latest meeting on Wednesday, Sept. 16, 2026. Going into the FOMC's announcement, CME Group's (NASDAQ:CME) FedWatch estimated the probability of a rate hike at a whopping 92.7%. FedWatch's odds of rate increases at the FOMC's October and December meetings are even higher.

What could happen with stocks if the Fed indeed raises rates for the first time since 2023? Here's what history says.

Image source: Federal Reserve.

Short-term pain

Wall Street is already bracing for short-term pain stemming from an expected interest rate increase. Goldman Sachs (NYSE:GS) analyzed historical stock market data following a Fed rate hike and found that the S&P 500 (SNPINDEX:^GSPC) fell by around 2% on average during the first three months of a new rate-hike cycle.

Some stock market declines were much worse than others. For example, the Fed began its last round of rate hikes with the FOMC meeting on March 17, 2022. Over the next three months, the S&P 500 sank roughly 17%.

Cycles when the Fed raised interest rates several times in rapid succession have typically resulted in steeper market sell-offs, according to Charles Schwab's (NYSE:SCHW) Liz Ann Sonders and Kevin Gordon. The 2022 and 2023 rate hikes were a textbook example of this, with the S&P 500 entering a bear market.

One challenge is that investors can't know for sure how much the Fed will increase rates. A Goldman Sachs team led by analyst Ben Snider recently wrote to investors, "Today even a modest hiking cycle would likely weigh on stocks because it would be difficult for the market to be confident in advance about the duration and magnitude of tightening."

Good news

There is some good news for investors if the FOMC announces a rate hike, though. While the S&P 500 has historically declined by an average of around 2% during the first three months of rate increases, Goldman Sachs found that the index's average 12-month return was a much healthier 9%.

How aggressive the Fed's rate hikes are matters. The S&P 500 jumped 10.5% on average during the 12 months following an initial rate increase when the rate tightening moved slowly, according to Schwab's Sonders and Gordon. However, the S&P fell an average of 3.6% in the first year during rapid-tightening cycles.

Goldman Sachs remains bullish on the market over the next year despite expecting a short-term pullback. Companies' earnings are growing briskly. Their balance sheets are wrong.

Schwab is on the same page. Sonders and Gordon recently wrote that the Fed's anticipated rate-hike cycle "likely won't be aggressive." They believe that the U.S. economy should have enough momentum to weather a round of modest rate increases.

Three concerning factors in 2026

Do investors have nothing to worry about with the Fed likely to increase rates? I wouldn't go that far. Three concerning factors in 2026 could complicate matters.

The first is the main reason the Fed feels the pressure to raise interest rates: persistent inflation. It's possible that developments in the Iran war, combined with the impact of President Trump's tariffs, could drive inflation even higher and force a more aggressive cycle of rate hikes.

Second, the stock market's valuation may become an issue. The S&P 500 Shiller CAPE (cyclically adjusted price-to-earnings) ratio is near its second-highest level since early 2000 -- right before the dot-com bubble burst.

Third, the massive investment in artificial intelligence (AI) infrastructure is a wild card that could make this cycle different from previous rate-hike cycles. AI-related capital spending is highly sensitive to the cost of money. Rate increases might throw a wrench into the AI boom that has fueled the current bull market.

However, historically speaking, the most likely stock market reaction to the expected Fed rate hike is short-term volatility, followed by a resumption of momentum. The main problem for investors is the uncertainty about whether or not history will repeat itself this time around.

Charles Schwab is an advertising partner of Motley Fool Money. Keith Speights has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CME Group and Goldman Sachs Group. The Motley Fool recommends Charles Schwab. The Motley Fool has a disclosure policy.