Energy only sector to gain 0.3% as Fed rate hikes begin

Market pricing now implies a Fed rate hike at the January 2027 FOMC meeting, and Barclays' study of five tightening cycles shows which sectors and styles have historically survived the first move.

The S&P 500 fell a median 3.9 percent in the quarter after the first Fed rate hike, with energy the only sector to gain, Barclays data show.

"The onset of a Fed hiking cycle has historically marked a clear inflection point for equity leadership," Venu Krishna, chief US equity strategist at Barclays, said in a report published Aug. 24.

The Russell 2000 small-cap index dropped a median 7.2 percent in the quarter following the first hike, while financials fared worst among sectors with a median decline of 8.4 percent. Health care, utilities and consumer staples also underperformed, while energy rose 0.3 percent — the only sector in positive territory across all five cycles.

The findings carry fresh weight as market pricing shifts toward a possible hike at the January 2027 FOMC meeting, with the 30-year Treasury auction yield reaching its highest level since 2001. Barclays economists expect no hikes through the first half of 2027, but the structural shift in rate expectations has investors reassessing sector positioning.

The study covered five tightening cycles — February 1994 to February 1995, June 1999 to May 2000, June 2004 to June 2006, December 2015 to December 2018, and March 2022 to July 2023 — spanning tightening driven by strong growth and by inflation suppression.

In the three months before the first hike, the S&P 500 posted a median gain of 2.2 percent, with energy and industrials leading, both up more than 7.5 percent. Communication services declined about 2 percent. Once tightening began, the pattern reversed sharply.

Why financials and defensives lag

Barclays attributed financials' weakness to tighter financial conditions and a flattening yield curve that pressures bank lending margins. Defensive sectors suffered valuation de-ratings as the Fed's move showed the economy was strong enough to warrant tightening.

Energy's resilience reflects its position in the late-cycle expansion, with commodity prices supported by solid real-economy demand. In all five full hiking cycles, energy's median annualized return ranked among the top sectors.

Value beats growth, large caps beat small

Across style factors, value outperformed growth in the two quarters after the first hike, with the rotation more pronounced in small caps, where growth trailed value sharply within the first two months. Momentum outperformed ahead of the first hike before turning range-bound, while the Fama-French small-over-large factor weakened for roughly two months post-hike before recovering.

The current backdrop differs from prior cycles in one key respect: the long-end yield surge. Barclays rate strategists attribute the rise in 30-year yields to large-scale long-duration bond issuance by AI-related companies and increasingly price-sensitive investors. The Treasury Department has intervened in the bond market to manage the rise, though the move itself has raised concerns about unintended consequences.

Barclays strategists cautioned that the conclusions rest on a limited sample of five cycles and past performance does not guarantee future results. But the consistency of energy's outperformance, financials' and defensives' underperformance, and growth's lag behind value across all five cycles gives the patterns some predictive weight.

This article is for informational purposes only and does not constitute investment advice.