The Federal Reserve's approach to interest rates has always been a closely watched and analyzed topic. Investors and analysts are constantly trying to predict the Fed's next move and its impact on the economy. Looking back at history can often provide valuable insights into the Fed's future actions.
One thing that stands out when examining the Fed's past rate hiking cycles is its reluctance to cut rates preemptively. The Fed has typically maintained an elevated policy rate until significant weakness has emerged in the economy. This means that the Fed waits for clear signs of material weakness before making any rate cuts.
A look at the past three rate hiking cycles is a good example of this.[0] In 2001, the Fed funds target rate remained at its terminal rate for almost eight months before any cuts were made.[0] Similarly, in 2007, the rate remained unchanged for nearly 15 months before the first cut. And in 2019, the rate was held steady for seven months before any cuts were implemented. This pattern suggests that the Fed prefers to wait for undeniable evidence of economic weakness before taking any action.
While the Federal Reserve is currently nearing the end of its rate hiking cycle, it is unlikely that it will conclude it just yet. The Fed will need additional data to be convinced that inflation is under control and declining, in line with its 2% target.[1] It is also crucial for the Fed to ensure that inflation expectations remain stable and not destabilized.[1] This means that the Fed will require more evidence and information before confidently deciding on the trajectory of interest rates.
It is important to note that the Fed has historically maintained an elevated terminal rate until something significant in the economy has broken. If the market is correct in predicting rate cuts, history suggests that we should expect swift and sharp cuts that may not be fully priced in.[0] Prior to each of the last three recessions, the Fed did not just make small cuts to address a contracting economy.[0] Instead, the cuts were substantial and decisive.
While it is reasonable to believe that the Fed is closer to concluding its rate hikes than it was last summer, the available data still indicate that further action may be necessary. Fed Chairman, Jerome Powell, is unlikely to corner himself by calling for a pause in rate hikes at this stage.[1] Instead, he will likely wait for more data to reinforce the Fed's commitment to being data-dependent.[1] The direction of monetary policy will be influenced by the overall health and strength of the economy.[1]
The idea that the Federal Reserve has already concluded its rate hikes is another instance of the market trying to create a familiar narrative of a Fed pause. However, history has shown that these predictions have often been inaccurate, as the Fed has consistently raised rates despite initial speculation of a pause.[1]
In conclusion, the Federal Reserve's approach to interest rates is grounded in historical patterns. The Fed has a tendency to maintain an elevated policy rate until it sees clear signs of weakness in the economy. While the current rate hiking cycle may be nearing its end, it is unlikely to conclude just yet. The Fed will require more data and evidence before making any decisions regarding interest rates. Investors and analysts should take these historical patterns into account when trying to predict the Fed's future actions.
0. “Stress Testing the Market’s Expectations for a Soft Economic Landing” FactSet Insight, 11 May. 2023, https://insight.factset.com/stress-testing-the-markets-expectations-for-a-soft-economic-landing
1. “Powell May Hang The Market Out To Dry Come Friday” Seeking Alpha, 16 May. 2023, https://seekingalpha.com/article/4605086-powell-may-hang-the-market-out-to-dry-come-friday
