How the coming Fed hiking cycle will differ – And why it matters
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With a Fed hiking cycle starting soon, we look at what previous hiking cycles looked like and how the current situation compares. In a coming paper we will look at how markets have fared during previous hiking cycles and what to expect in this cycle.
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We see some key differences in the current situation compared to previous hiking cycles. Most importantly, the Fed looks to be a lot behind the curve, which calls for more front-loaded tightening than normal.
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Another key difference important for not least bond markets is, that the yield curve is unusually flat in comparison with previous rate take-offs. We thus expect to see outright selling of bonds by the Fed (‘active’ QT) as part of the tightening in order to postpone an inversion.
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This is unchartered territory for hiking cycles and in our view adds upside risk to long bond yields. It also supports the case for higher risk premia in risk markets.
Stylized facts about hiking cycles
When looking at the previous hiking cycles, we choose to only include the past 30 years as for example inflation expectations were much less anchored before that (see chart). It provides us with four hiking cycles in total 1994-95, 1999-2000, 2004-06 and 2016-2018). The chart on page 2 shows the cycles with stats on length, hikes per year etc. Here is a summary of the key findings:
1. Hiking cycles have lasted 1-2 years (longest was 24months, shortest 11 months)
2. Policy rates were cut within 8 months from the last hike in three cases and 15 months after in one case (2004-06 cycle). In two of the four cycles, the US was in recession within a year from the last hike. In both cases, though, it followed asset bubbles (in 2001 the IT bubble and in 2007 the housing bubble).
3. It is more than 20 years ago the Fed has hiked rates by 50bp (changes of 50bp are much more common in rate cut cycles).
4. The Fed has not started a hiking cycle with 50bp since the 1980s.
5. The most recent 2016-18 cycle was the ‘softest’ path. The Fed hiked four times per year and 25bp at each meeting (we here ignore the lonely hike in December 2015).
6. The 2004-06 hiking cycle was the longest. It lasted 25 months and the Fed hiked 25bp at each meeting for 17 meetings in a row. They described it as ‘measured pace’.
7. The shortest cycle was the 1999-2000 cycle that lasted 7 months (total hikes of 175bp).
Author
Danske Research Team
Danske Bank A/S
Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.
