Key Points

• The Fed recently lifted interest rates to address rising inflation.

• A look at history offers us clues about what may happen next.

• 10 stocks we like better than NASDAQ Composite Index ›

Less than a year ago, the Federal Reserve continued along a path that began in 2024. The central bank was in the middle of a series of interest rate cuts, something that is generally seen as supportive of consumers and companies -- particularly growth players such as those in the field of technology. But in recent months, as inflation rose, the central bank halted that trend, and it became clear that a policy shift was on the way.

That shift happened last week when Fed chair Kevin Warsh increased interest rates by a quarter point, marking the first such move in three years. Now you may be wondering if the tech-heavy Nasdaq Composite will drop in the months to come. History offers an answer that's strikingly clear.

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A rate hike leads to higher borrowing costs for consumers

So, first, let's consider why an increase in the federal funds rate is often seen as a headwind for stocks. This is for a few reasons. An increase in this key rate has a trickle-down effect, resulting in higher credit card rates, as well as higher rates for certain home loans like adjustable-rate mortgages, and new auto and student loans. One interest rate hike probably won't make a big difference for most borrowers, but it's still unclear whether this recent move was isolated or would lead to additional increases. The CME FedWatch tool shows a 53% probability of a rate hike during the Fed's October meeting.

The result of higher rates on the consumer is weaker buying power. So the consumer who would readily buy various goods and services may now rein in spending and focus on buying essentials. This could impact the sales of certain companies, including those on the Nasdaq.

Nasdaq companies also may see less investor demand for their shares as some investors turn to bonds -- their yields, particularly short-term treasury yields, often move along with the Fed's rate decisions. So, the idea here is that investors may get a solid return from bonds, and these are lower-risk investments. On top of this, knowing that this trend may unfold, some investors might anticipate weaker stock performance and favor the bond market.

Meanwhile, higher interest rates also equal higher borrowing costs for companies, and this can add to the costs of those investing in growth, such as the tech and other growth companies found on the Nasdaq.

As I mentioned above regarding impact on the consumer, this single rate hike won't drastically increase borrowing costs for companies. But it's still a point to watch and could make investors hesitate before investing in growth stocks.

Rate hikes in 2015 and 2022

And this leads me back to our question: Will the Nasdaq decline in the months following this recent interest rate increase? For some clues, I looked back at the interest rate moves that launched the past two increase cycles. Those were the rate hikes in March of 2022 and December of 2015.

Both times, in the six months to follow, the Nasdaq declined -- by 4% after the 2015 hike and by 15% following the 2022 increase. But, before you feel discouraged by this news, consider this. Exactly two years after that first increase, the Nasdaq soared in the double digits each time -- by 38% after the 2015 increase and by 17% after the 2022 increase.

So, history shows us that the start of an interest rate increase cycle could lead to declines in the Nasdaq in the near-term, but importantly, the index has not only recovered but gone on to significantly gain over a longer period. History offers us an answer that's strikingly clear: While rate hikes may weigh on the index's performance for a few months, such a pattern has been temporary. And if we look at the index's performance over several years, we can see that it's always gone on to climb after tough periods -- regardless of what element set off the downward momentum.

All of this means that, if the Nasdaq falls, investors should look for opportunities to buy quality stocks at a discount and hold on for the long term.

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Adria Cimino has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.