The Fed Could Raise Interest Rates Again This Year. Here's What That Might Mean for the Stock Market.

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The Federal Open Market Committee (FOMC) raised interest rates for the first time in three years in September, boosting the range by a quarter point to 3.75% to 4.00%.

While it was not unexpected with inflation spiking following the war in Iran and remaining elevated, a year ago at this time, most people thought rates would be declining in 2026, not rising.

Here we are heading into the FOMC's next meeting on Oct. 28 and it appears that the September hike was not a one-off. The CME FedWatch survey says 17% of interest rate traders expect a 25 basis point rate hike in October, but that bumps up to 63% for the Dec. 6 meeting.

So if it doesn't come in October, a strong majority see another rate hike coming by the end of the year.

Markets don't typically react positively to interest rate hikes, but the S&P 500 did rally about 2% the week after the Sept. 16 Fed meeting. Of course, it had declined about the same amount in the weeks leading up to the meeting as investors anticipated the rate increase.

Short-term volatility around interest rate decisions is fully expected. Long-term investors should largely tune out that noise around individual FOMC moves and look at longer-term trends.

Even higher for even longer

The more interesting Fed news that came out on Sept. 16 was the summary of projections, also known as the dot plot. The dot plot, where FOMC members predict the path of rates and various economic indicators with literal dots on a page, gives a little more to go on.

The dot plot comes out every quarter, and the September quarterly dot plot shows a significantly different view than the one from just three months earlier.

While the FOMC members expect personal consumption expenditures (PCE) inflation to steadily fall in 2027 to 2.3% and 2.1% in 2028, their outlook for rates remains even higher for even longer.

The September dot plot sees the federal funds rate not budging in 2027, staying at 4.1%, the same as where it's projected to end 2026. In June, the FOMC had projected the rate to end 2026 at 3.8% and to finish 2027 at 3.6%, which would be one rate reduction.

In the September dot plot, the FOMC anticipates a rate of 3.9% in 2028 and 3.6% in 2029. Essentially, it will take us three years to get one rate cut from where we are now. The June FOMC projected a 3.4% median rate in 2028 and a 3.1% rate in 2029.

Now, these are not set in stone and can change significantly, as we have seen over the past three months. But if you are seeing this as an investor, it should inform your strategy.

What you should be looking for

There is now even more reason to believe that the higher for longer scenario is here to stay for a while. As an investor, that doesn't mean it's time to panic, it just means it's time to adjust and make sure you are prepared for this potential scenario.

It really doesn't require drastic changes for a potentially higher-for-longer environment, but there are some things to prioritize. Look for stable companies that are well-capitalized with abundant cash and free cash flow. Higher rates increase borrowing costs, so companies with ample capital can continue investing in their growth. Also, look for companies with pricing power that can raise prices at or beyond the level of inflation to protect their margins and potentially increase market share.

Overall, look for stable, high-quality companies at reasonable or cheap valuations. They will be better able to navigate the inevitable volatility and corrections that may occur. It helps if these stocks pay reliable dividends, because that means they have an abundance of cash, and those dividends can be reinvested to boost returns.

And, as mentioned, don't make drastic changes. Even if you have a growth stock that's way overvalued, make incremental changes; don't make all-in or all-out decisions. That's because markets can change, and you don't want to overreact and make an emotional decision on a stock that you previously saw long-term value in when you took your initial position.

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