How Will Mr. Market Respond to Fed Rate Hikes?

Includes: DIA, QQQ, SPY
by: Bob Lang
Out of Ammunition?

'Well, whaddaya know?  No more bullets!'...Elmer Fudd

This is probably the same feeling the Fed has right about now.  Not much left to fire from a gun full of blanks.  It's now a matter of work it out on your own.  The inflation picture continues to look muddled and with elevated prices seen anywhere but where the government is surveying...well, the truth will eventually matter. 
Friday saw another sharp rise in consumer prices, with inflation near the 5% level on headline.  This must concern the Fed and likely puts a halt to any more stimulus.  In fact, the strong retail sales figure virtually locks in some growth for the second quarter, once again skirting a recession.  At this point, the Fed has to acknowledge the inflation problem and start working on it NOW.
Taking Back Rates
If watching the economy for clues of growth, the Fed is wise.  Once the economy is on its feet again, the rate cuts should be reversed and the Fed Funds rate brought back up to normal levels (4-5%).  However, inflationary trends may force the Fed to raise rates sooner than hoped for and further in a tightening cycle.  The talk of being tough on inflation will end soon with a series of rate hikes. 
But how will the market respond?  Looking back at the last rate hike cycles, the economy was lifted in 2003 from a dreadful recession.  Back then, the housing sector led the way with an enormous rise in home values.  Greenspan started to raise rates from the 1% level and Bernanke finished the job to 5.25%.  What did the market do?  It rose during that period!  Will the same thing occur?  I would find it hard to believe this fragile market would respond favorably to rate hikes, but you never can tell.
Market Action
Friday's rebound was nice, but was it a start?  Clearly the markets had been oversold, and bounces in a bear market are sharp.  Given the vast damage of charts just from last week, the onus is on the bulls to push higher, but there has been no washout of selling which just delays the inevitable.  Buy the dips, sell the rips is still the mantra.
Disclosures: None