On Friday, June 5, the S&P 500 (SNPINDEX: ^GSPC) retreated 2.6% and the Nasdaq Composite (NASDAQINDEX: ^IXIC) dropped 4.1% following an unexpectedly strong payroll report. Jobs growth has now exceeded 100,000 in three straight months, something that last happened in early 2024.
The stock market interpreted that as bad news because inflation recently hit a multiyear high, which means the probability of interest rate cuts is essentially zero. In fact, investors now expect the Federal Reserve to raise rates, and the pivot to rate hikes has historically caused stocks to drop.
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But will the stock market crash if the Fed raises rates? Here’s what investors should know.
Investors think the Federal Reserve will raise rates by a half percentage point in the next 15 months
In December, CME Group‘s FedWatch tool — which calculates the probability of different interest rate levels based on futures contract prices — signaled two quarter-point rate cuts as the most likely outcome in 2026. But the economic backdrop is much different today, and investors now expect two quarter-point rate hikes by September 2027.
What changed? The labor market looks more resilient. The U.S. economy added just 116,000 jobs last year as businesses navigated an uncertain trade environment. That was the slowest pace of hiring since the COVID-19 pandemic in 2020. But the economy has already added 569,000 jobs this year.
“What we’re seeing here is the catch-up from last year where employers were on pause,” Wells Fargo senior economist Sarah House explained to The Wall Street Journal. She added, “Employers have a better sense of the growth backdrop” because uncertainty surrounding President Donald Trump’s tariffs has dissipated to some degree.
Meanwhile, inflation has accelerated since Trump authorized military operations in Iran. The Consumer Price Index (CPI) recorded a year-on-year increase of 3.8% in April, the highest reading since May 2023. And CPI inflation probably topped 4% in May, though the official number won’t be published until June 10.
So what? The Federal Reserve sets monetary policy with two objectives in mind: stable prices and maximum employment. With the jobs market looking less fragile, the Fed has more freedom to raise interest rates without fear of triggering a recession.
