FOMC Preview: Does Not Hike Automatically Mean Bullish for Stocks? An Unintuitive Logic
The July FOMC meeting ends tomorrow. Based on interest rate swap market pricing as of July 28, traders estimate there’s about a 70% probability that the Federal Reserve will keep rates unchanged, and about a 30% probability of a 25-basis-point hike.
The market typically interprets “no rate hike” as a short-term positive: if the policy rate doesn’t keep rising, the pressure facing stocks seems to ease.
This time, you need to look one step further.
If the Fed holds steady, it could weaken market trust in the Fed’s resolve to fight inflation, and the real yield curve could steepen again.
Short-term sentiment gets buffered, but mid-term valuation pressure could rise. Since this year, the U.S. real yield curve between the 2-year and 10-year maturities has overall been steepening if the Fed does not hike.
As the 10-year real yield rises, the 2-year real yield actually falls. One reason is that the inflation growth rate has outpaced the change in the 2-year nominal yield, causing short-term real rates to drift lower by default. In the past month, the curve has somewhat flattened. The market has priced in more expectations of further hikes, and the Fed has also not clearly ruled out those expectations. If the final outcome is no hike, the trading logic may flip again. If the market believes the Fed is not tough enough on inflation, short-term real yields may pull back;
at the same time, a rebound in inflation expectations could keep long-term real yields elevated, or even push them higher. With the two ends moving in opposite directions, the curve would steepen again. This steepening does not come from stronger growth expectations. It reflects another concern: that current inflation pressure may last longer, requiring higher policy costs in the future.
The stock market will be affected through two layers. One is the discount rate. When long-term real yields rise, it directly lowers the present value of distant cash flows. Valuations that rely on growth in earnings far out in the future—especially technology and AI-related assets—are particularly sensitive to these changes. The other is the policy risk premium. Once the market starts worrying that the central bank is behind the inflation curve, investors will set aside room for more aggressive tightening in the future. Even if there is no hike on the day, policy uncertainty can still drag down overall risk appetite.
It’s also worth looking at historical parallels. From 2020 to 2022, the degree of steepening in the real yield curve exceeded that of the late-1970s to early-1980s high-inflation period. In the same phase, stocks saw a noticeable valuation compression and amplified volatility. This doesn’t mean history will repeat in exactly the same way, but it shows that the curve’s shape cannot be understood only as “rates not being raised.” What matters after the decision is what rates determine is only the first layer of information. How the statement describes inflation—and whether it reintroduces the possibility of further hikes—will influence the market’s judgment of the subsequent path.
沃什’s wording at the press conference is also important.
Since taking office, he has given relatively few proactive, clear forward-looking signals. If this time he remains restrained, the market may continue to price matters on its own via the yield curve; if he clearly strengthens anti-inflation language, whether pressure on the long end eases will become a direct test. Oil prices are another external variable. If the Hormuz blockade persists and Brent crude stays above $100 per barrel, supply shocks will make policy choices more difficult. Rate hikes cannot increase oil supply, but persistently high oil prices will enter the inflation data and force the Fed to respond.
Therefore, no hike can bring short-term sentiment support, but it doesn’t necessarily reduce mid-term pressure on stocks. What’s more important to watch is whether the decision can sustain market trust in the Fed’s ability to fight inflation, and how the real yield curve changes after the meeting.
This article is for discussing market mechanisms only and does not constitute investment advice.
The July FOMC meeting ends tomorrow. Based on interest rate swap market pricing as of July 28, traders estimate there’s about a 70% probability that the Federal Reserve will keep rates unchanged, and about a 30% probability of a 25-basis-point hike.
The market typically interprets “no rate hike” as a short-term positive: if the policy rate doesn’t keep rising, the pressure facing stocks seems to ease.
This time, you need to look one step further.
If the Fed holds steady, it could weaken market trust in the Fed’s resolve to fight inflation, and the real yield curve could steepen again.
Short-term sentiment gets buffered, but mid-term valuation pressure could rise. Since this year, the U.S. real yield curve between the 2-year and 10-year maturities has overall been steepening if the Fed does not hike.
As the 10-year real yield rises, the 2-year real yield actually falls. One reason is that the inflation growth rate has outpaced the change in the 2-year nominal yield, causing short-term real rates to drift lower by default. In the past month, the curve has somewhat flattened. The market has priced in more expectations of further hikes, and the Fed has also not clearly ruled out those expectations. If the final outcome is no hike, the trading logic may flip again. If the market believes the Fed is not tough enough on inflation, short-term real yields may pull back;
at the same time, a rebound in inflation expectations could keep long-term real yields elevated, or even push them higher. With the two ends moving in opposite directions, the curve would steepen again. This steepening does not come from stronger growth expectations. It reflects another concern: that current inflation pressure may last longer, requiring higher policy costs in the future.
The stock market will be affected through two layers. One is the discount rate. When long-term real yields rise, it directly lowers the present value of distant cash flows. Valuations that rely on growth in earnings far out in the future—especially technology and AI-related assets—are particularly sensitive to these changes. The other is the policy risk premium. Once the market starts worrying that the central bank is behind the inflation curve, investors will set aside room for more aggressive tightening in the future. Even if there is no hike on the day, policy uncertainty can still drag down overall risk appetite.
It’s also worth looking at historical parallels. From 2020 to 2022, the degree of steepening in the real yield curve exceeded that of the late-1970s to early-1980s high-inflation period. In the same phase, stocks saw a noticeable valuation compression and amplified volatility. This doesn’t mean history will repeat in exactly the same way, but it shows that the curve’s shape cannot be understood only as “rates not being raised.” What matters after the decision is what rates determine is only the first layer of information. How the statement describes inflation—and whether it reintroduces the possibility of further hikes—will influence the market’s judgment of the subsequent path.
沃什’s wording at the press conference is also important.
Since taking office, he has given relatively few proactive, clear forward-looking signals. If this time he remains restrained, the market may continue to price matters on its own via the yield curve; if he clearly strengthens anti-inflation language, whether pressure on the long end eases will become a direct test. Oil prices are another external variable. If the Hormuz blockade persists and Brent crude stays above $100 per barrel, supply shocks will make policy choices more difficult. Rate hikes cannot increase oil supply, but persistently high oil prices will enter the inflation data and force the Fed to respond.
Therefore, no hike can bring short-term sentiment support, but it doesn’t necessarily reduce mid-term pressure on stocks. What’s more important to watch is whether the decision can sustain market trust in the Fed’s ability to fight inflation, and how the real yield curve changes after the meeting.
This article is for discussing market mechanisms only and does not constitute investment advice.
