Five charts on the Fed raising interest rates

Over the last 30 years or so, we have seen four major tightening cycles by the Fed. Under what circumstances did the Federal Reserve start raising rates, and how do these circumstances compare to the current situation?

Graph 1 – The Fed & The Economy

The graph below shows the level of the Fed Target Rate (on the left axis) and the ISM index (on the right axis.) To dilute the effect of temporary factors influencing the ISM index, I took the three-month average, which is, of course, completely arbitrary. The graph shows that there is quite some dispersion in the ISM index levels that coincide with the start of Fed hiking cycles (the starting point of each cycle is marked by a green circle.) In 2004 the ISM index stood above 60, while in November 1986 the index measured ‘just’ 51.2. The ISM index averaged 55 (dotted line) at the start of all four hiking cycles. In each case, however, the ISM Index topped 50, signalling strengthening manufacturing growth. The most recent reading of the ISM index is 53.5…

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Graph 2 – The Fed and Current Inflation

The graph below shows the level of the Fed Target Rate (on the left axis) and Core PCE Index (on the right axis.) Since the peak in inflation during the ‘70s, inflation levels have been trending down. This trend is, to some extent, mirrored by the Core PCE levels at which the Fed started hiking rates (green circles.) This makes the average Core PCE level perhaps a little bit less informative. An important take away, however, is, that in 1999 the hiking cycle took off at the same depressed level of Core CPE as the one we have currently…

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Graph 3 – The Fed and Future Inflation

The graph below shows the level of the Fed Target Rate (on the left axis) and expected inflation (on the right axis.) Looking at realized inflation numbers is a bit like looking in a rear-view mirror. That’s why central banks are so keen on focusing on expected inflation. The graph below reveals that Fed hiking cycles pretty much always start at the same level of expected inflation. Mind you, this graph probably says more about the credibility of the Fed, than about hiking cycles. The graph shows people expect the Fed to hit its target most of the time. Anyway, the current level of expected inflation should be no obstacle for starting a hiking cycle…

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Graph 4 – The Fed and Unemployment

The graph below shows the level of the Fed Target Rate (on the left axis) and unemployment (on the right axis and inverted.) On average, the Fed initiated a hiking cycle at an unemployment level of 5.9% (dotted line.) For June, the Bureau of Labor Statistics reported an unemployment level of 5.3%, which is considerably lower than the four-cycle average. We should take into account, however, that the NAIRU, the Non-Accelerating Inflation Rate of Unemployment, has come down over time. The Fed can simply wait for lower levels of unemployment before raising rates. Still, the current level of unemployment of 5.3% shouldn’t be a reason to not lift rates, given the fact that the OECD estimates US NAIRU to be 5.45% …

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Graph 5 – The Fed and Job Growth

The graph below shows the level of the Fed Target Rate (on the left axis) and job growth (on the right axis.) By looking at the number of jobs created we can circumvent issues like unemployment definitions, participation rates, and so on. The graph reveals that, with the exception of the hiking cycle that began in 1986, the level of job creation at which the Fed starts hiking rates is pretty similar. On top of that, the average of 210K jobs per month exactly matches the level of current job growth…

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Thank you!

 

2 responses to “Five charts on the Fed raising interest rates

  1. Pingback: Week End Blog – Emerging Market Meltdown! | Jeroen Blokland Financial Markets Blog·

  2. Pingback: Week End Blog – Limit Downs, PMIs and Fed Anxiety | Jeroen Blokland Financial Markets Blog·

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