The Federal Reserve has started its tightening cycle and the central bank’s economic projections point to a faster pace of rate increases than expected. Equities have rallied, with the S&P 500 ending last week up 6.2%, despite the Fed’s more hawkish stance. Economists at UBS think this move is justified.

Fed’s turn of speed isn’t inconsistent with rising stocks

“The Fed is re-establishing its inflation-fighting credentials, which is positive for long-term growth. Markets initially appeared to welcome the Fed’s efforts to get ahead of the curve with the 5-year/5-year forward inflation swap, a market-based measure of longer-term inflation expectations, falling from 2.65% to 2.51% after the rate decision.”

“A flattening of yield curves is not a sign that markets expect an imminent recession. Even when a recession did follow an inversion, there was a long and variable lag. Recessions started, on average, 21 months after an inversion, with a range of 9-34 months. Since 1965, the S&P 500 has returned an average of 8% in the 12 months following a 2-year/10-year inversion.”

“Equity performance tends to be positive at the early stages of a rate hiking cycle. Since 1983, the S&P 500 has returned an average of 5.3% in the six months following the first Fed rate rise.”

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