The stock market could do something strange this week after the Fed decision

• Fed funds futures show 90% probability of a quarter-point rate hike to 3.75%-4.00% range, with two more increases expected by year-end
• The 10-year Treasury yield crossed 4% for the first time since 2023, as investors prioritize bond market stability over typical rate hike concerns
• Historical data shows the S&P 500 typically drops 3.4% in the month following initial rate hikes, but analysts believe much bond yield repricing is already complete, potentially clearing the way for equity gains

Market Summary: Fed Rate Decision Could Trigger Unusual Stock Rally

Key Developments

The stock market may exhibit an atypical response this week by rallying despite an expected Federal Reserve rate hike. Markets are pricing in a 90% probability that the federal funds rate will rise to 3.75%-4.00% following Wednesday's decision, with additional increases likely in October and December.

Market Dynamics

Contrary to normal patterns where stocks decline on rate hike prospects, equities could rise as investors prioritize bond market stability. The unusual setup stems from inflation concerns driving longer-dated Treasury yields higher, making rate hikes potentially beneficial for anchoring long-term yields.

The 10-year Treasury yield crossed a significant threshold for the first time since 2023 on Monday, pressuring equities across major averages.

Critical Factors

Chairman Warsh's Tone: Market reaction hinges on whether the Fed chair maintains his hawkish Jackson Hole stance or reverts to July's vague commitment to fighting inflation.

• Hawkish scenario: 2-year yields rise 5-10 basis points; 30-year rates fall equally
• Dovish scenario: 2-year yields fall 5 basis points; 30-year rates rise 5 basis points

Historical Context

Bank of America's Mark Cabana warns the Fed faces a stark choice: "hike or risk large bond spike." Historical data from Canaccord Genuity shows the S&P 500 typically drops 3.4% in the month following initial rate hikes across six tightening cycles over 30+ years.

However, JPMorgan's Mislav Matejka suggests most bond yield normalization is complete, potentially clearing the path for equity gains through year-end if the Fed successfully restores anti-inflation credibility.