How Far Will the FED go? History Holds Clues

A year ago, just after the Federal Reserve hiked for the first time in the current cycle, I wrote an article here on ETF Trends about what we should expect if this rate hike cycle turns out to be similar to previous ones in recent history.

So far things have not played out as in previous cycles since the FED waited a full 12 months between the first and second rate hike.

Let us quickly review what the FED has done the last few times they initiated a major policy shift:

(Click to enlarge) Chart courtesy of Bloomberg

(Click to enlarge) Chart courtesy of Bloomberg

Starting in the late 1980’s, we had a series of rate cuts that eventually brought the FED funds rate down to 3% by 1992. The rate then stayed there until February 1994. The FED Funds rate is the orange line in the chart above. The white line is nominal Year-on Year GDP growth (GDP growth including inflation). When the FED started tightening in early 1994, nominal GDP was running right around a 5% annual rate. A year later, on February 1, 1995, the FED was done tightening with the Fed Funds rate having reached 6%. At the time, this was roughly in line with nominal GDP growth.

The next significant policy change came in January 2001, when the FED embarked on a new round of easing in response to the post-bubble recession.  By the summer of 2003, the FED funds rate had fallen to 1%, where it stayed for about a year until a new tightening campaign began.

As can be seen on the chart, a huge gap between FED Funds (at 1%), and nominal GDP (above 6%) had once again opened up by 2003, and the tightening campaign once again closed that gap.

By the summer of 2006, the Funds rate hit 5.25% and stayed there until September 2007, when the FED started to see downside risks to growth from a slowing housing market. This was, as we now know, the beginning of the Global Financial Crisis, which ultimately required a whole slew of emergency measures to contain it. One of these measures was a sustained FED Funds rate of zero to .25%, which, having been initiated on December 16, 2008, was the official rate until December 16, 2015, exactly seven years later.