The Fed Just Raised Rates for the First Time in Three Years. History Says This Is What Comes Next.

The Federal Reserve raised interest rates rapidly in 2022 and 2023 in response to inflation rising to a multi-decade high. And ever since then, investors have mainly wondered how quickly rates would fall, and when we entered 2026, most didn't feel that the rate cuts were done yet.

However, after a significant increase in inflation this year, the Fed reversed course and tightened monetary policy. On Sept. 16, the Fed announced its first rate hike in three years, a 25-basis-point increase to a federal funds rate target range of 3.75%-4%. The move was small, but it marks the official start of a tightening cycle.

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What should investors expect? Here's what history says about stock market returns after the Fed starts tightening, and how you can adjust your portfolio for the new environment.

The short answer is inflation . The Fed's statement accompanying the rate hike said inflation remains elevated and that the hike is intended to support a quicker return to the central bank's 2% inflation target. Chair Kevin Warsh said in his press conference that recent inflation data doesn't show significant improvement, so action was necessary.

What history says about the start of a tightening cycle

Here's the short version. The S&P 500 has historically been weak for the first few months after a tightening cycle begins, but recovers fairly quickly.

In fact, by the 12-month mark following the first hike of a cycle, the S&P 500 has historically been higher by an average of about 6.7%. Of course, the exact performance varies with each rate-hike cycle, but a key point is that the S&P 500 produced positive returns in every 12-month period following the start of a rate-hike cycle except one. If you're curious, the only exception was in 2022, when there was a fast and aggressive rate-hike cycle with several "triple rate hikes" to combat generationally high inflation.

In a nutshell, some initial weakness is normal and has historically been a buying opportunity, not the start of a long-tailed decline, even if the Fed continues to raise rates. What's more, in slow-paced rate hike cycles, the S&P 500 averaged a gain of 10.5% over the next 12 months. The Fed's expectation right now is for one more hike this year and no rate changes this year, so it's looking like a slow cycle so far.