When the Fed hikes: what happens next?
not today's biz but at some point, WHEN they hike, rates, ON AVERAGE, decline
A large German bank analyst and fan favorite in the EZ shared his latest (Monday) CoTD … of what happens WHEN Fed HIKES. Clearly NOT today’s or this weeks FOMC biz but for those inquiring minds,
… Want to know why Treasury yields have been falling even though inflation is soaring and a Fed hiking cycle is on the way?
Well maybe history can help. Today’s CoTD is from a new note I wrote with Henry Allen this morning (link here) looking at what happens to growth, inflation and various asset prices before and after the first hike in a Fed hiking cycle. We’ve identified 13 cycles since the early 1950s.
The chart shows that for 10yr US Treasuries, yields historically move slightly lower on average in the year leading up to the first hike and then turn higher almost immediately around the first hike in the cycle and continue rising for a year. The outcomes are skewed to the upside looking at the range of cycles in the graph. However they start to fall again in years two and three of the hiking cycle as the economy slows and the next recession creeps into view. Indeed we’ve found that the median/average recession occurs 3/3.5 years after the first hike. In the first year, growth, equities and inflation stay strong. It’s only in the second year after that we start to see weakness.
See the full note for what exactly happens to growth, inflation, equities, yields, credit spreads and the yield curve. The yield curve conclusions are fascinating.
Fascinating, indeed…Years 2 and 3 of hiking cycles SOUNDS good but these days, well, we’re far from normalized (starting points, ultimate end games, expectations etc) SO consider the entirety OF the situation.
One thing that is constant, when the Fed pulls the punchbowl away we typically get the same reflex in rates…on average…
Meanwhile, from Mrs 750k NFP, the only FOMC pre-cap you’ll really EVER need (or the only one to completely ignore — we’ll see after Wednesday afternoon),
Look for a majority of hawks to push rates higher…
… All that said, the forecasts that the Fed releases with the conclusion of this meeting will be historic and make news. We are expecting a majority - maybe even a plurality - of meeting participants to pencil in at least one rate hike. Some could have four rate hikes planned for 2022. Those shifts, coupled with higher forecasts for inflation and lower forecasts for unemployment, will mark the first time the FOMC has openly acknowledged a need to chase, instead of preempt, inflation since the 1980s.
The statement regarding policy will be tweaked to acknowledge much stronger overall growth and inflation. Powell went to great lengths in his testimony to Congress to say that the term “transitory” should be dropped when it comes to talking about inflation. As we feared, inflation has become more broad-based and will likely remain that way even if inflation abates from the red-hot pace we are currently enduring. Watch closely for inflation in medical and shelter costs to pick up in 2022, even as inflation on goods begins to abate. The great unknown is what role the current Delta wave and concerns over Omicron will have on supply chains. The Fed has now concluded that outbreaks are in and of themselves inflationary because of how much they can further muck up global supply chains.