Stop! In the Name of Lags
They did it. They stopped hiking…for now, at least. The fed funds rate remains at an upper bound of 5.25%, and the June meeting marks the first one in 15 months that didn’t result in a rate hike.
By the time today’s statement was released, a “skip” (i.e., no hike at this meeting, but a likely one at the next) was priced into markets. But according to the FOMC’s own projections of the terminal rate, two more hikes are expected before the end of the year with the median projection moving from 5.1% to 5.6%. I have my doubts, but more on that below.
The market isn’t buying it, and is only pricing in one more hike in either July or September. There’s still some disagreement between the market and the Fed, which means one or both of them will be wrong. Regardless of whether there will be more hikes, the main message from Jerome Powell today was that the process is not over.
But now the process we’re referring to is less about rate hikes and more about the effect of them working through the economy. If it’s not the hikes that’ll getcha, it’s the lagged effects that will.
How Different Can This Be?
We can slice and dice the data in a million different ways, but the crux of the argument between bulls and bears right now lies in the below chart. After an aggressive hiking cycle, what can we typically expect?
Each cycle has been slightly different, but a few takeaways are generally true historically, according to this chart. First, more often than not, a hiking cycle is followed by an economic contraction. Second, the only time during this period when hikes weren’t followed by a recession (the mid-1990s) resulted in a “higher for longer” rate regime, with a fed funds rate above 5% for four years. Third, relative to prior hiking cycles, this one has been steep.
Using historical data does have its limitations, as we know that the world is different today than it was 50 years ago, but it is useful when we’re trying to understand how things have happened in similar circumstances before.
That said, this chart doesn’t give me confidence that this hiking cycle will end differently than others. The reality is that the times when these circumstances haven’t resulted in a recession are the exception, not the norm. Not impossible, but rather improbable.
Actions Speak Louder
Call it what you will: a hawkish pause, a skip, or a summer vacation. It doesn’t stop the effects of previous hikes from continuing to bake through the economy. I also maintain the opinion that last month’s hike was the last one; I think this is a pause that will stick until we see rate cuts. I’m taking today’s action (or lack thereof) as more important than the words that accompanied it.
Given that one of the main reasons for pausing the hikes was to allow the lagged effects to make their way through the data, making a declaration right now that we are headed for a soft landing, still feels very premature to me.
I know that the stock market looks optimistic, and I know that’s different from what my take has been for a while. It has certainly made me look again, revisit, re-do the analysis, start from scratch and see if I come up with a different view. I’ve come away with different levels of frustration each time, but not a different view.
We are getting to the end of this hiking phase, but we’re not done with the lingering impacts of it. Just because the late part of this cycle is taking a long time, doesn’t mean it’s going to end differently.
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