Planning For Future Rate Hikes: What Can History Tell Us That The Fed Won't?

Tyler Durden's picture




 

Submitted by F.F.Wiley of Cyniconomics blog,

It stands to reason that when the Fed eventually lifts interest rates, we’ll see the usual effects. After a sustained rise in rates, you can safely bet on:

  1. Fixed investment and business earnings dropping sharply
  2. GDP growth following investment and earnings lower
  3. Many people losing their jobs
  4. Risky assets performing poorly

These consequences follow not only from the arithmetic of debt service and present value calculations, but also from the mood swinging psychology of entrepreneurs, lenders and investors.

Yet, policy economists claim that interest rates can be “normalized” at no cost.

For example, while speaking last week about the fed funds rate, St. Louis Fed President James Bullard said the economy was strong enough to “tolerate at least a little bit of the central bank getting back to a more normal stance.”

And how should we interpret “a little bit”?

According to FOMC projections, a little bit of normalization gets underway sometime next year and then leads to a steady pace of policy adjustments that doesn’t stop until the fed funds rate reaches almost 4%. These projections are accompanied by predictions for an improving economy as policy tightens.

Escape velocity or escape from reality?

The FOMC simply doesn’t acknowledge the time-tested effects of rising interest rates noted above. Instead, central bankers argue that today’s monetary stimulus will produce such economic vitality that there’s no sting in tomorrow’s tightening. In other words, they forecast an “escape velocity” where the economy is presumed immune to monetary restraint.

But is there any basis for their beliefs in the economy’s actual workings?

Or, is escape velocity merely a convenient story for central bankers predisposed towards easy money and short-term thinking?

We’ve argued that the Fed’s current policymakers have exactly this predisposition, and that there’s no such thing as escape velocity. We’ve also shared historical evidence supporting our views – in “M.C. Escher and the Impossibility of the Establishment Economic View,” for example – and take another look at history in this post.

Our analysis starts with a breakdown of interest rate changes over all 4 and 8 quarter periods since 1955:

rate hikes 1

We then review economic outcomes conditioned on the rate buckets above, recording the median outcome for each bucket. In most cases, we compare interest rate changes to outcomes for subsequent (lagged) 4 and 8 quarter periods.

(See this technical notes post for further detail. Also, look for a future follow-up post where we’ll contrast the history shown below to the Fed’s forecasts.)

Here are the results for fixed investment, corporate earnings, GDP and unemployment:

rate hikes 2

rate hikes 3

rate hikes 4

rate hikes 5

And here are charts showing the effects of changing interest rates on stock and house prices:

rate hikes 6

rate hikes 7

rate hikes 8

Now, many readers will surely dismiss these results by insisting that “this time is different.” We beg to differ. By our estimates, the economy and financial markets are as vulnerable to higher rates as they’ve ever been. Here are a few reasons:

  1. The present expansion is weaker than any other post-World War 2 expansion, suggesting that it won’t take much of a slowdown to push the economy into recession.
  2. Monetary policy has been exceptionally loose for longer than ever before, allowing financial markets more time to become overpriced and complacent.
  3. There are many more risk-takers in the global economy who’ve learned how to exploit cheap dollar policies than there were in, say, 1955, the start of the period shown in the charts.
  4. Most importantly, aggregate debt is at or near record levels, not only in the U.S. but also in other large economies.

Bottom line

Our conclusion is to reject forecasts calling for the economy to power right through interest rate hikes without stumbling. A more likely scenario is that policy “normalization” leads us directly into the next bust. Alternatively, the Fed might abort its planned rate hikes, allowing economic and financial market imbalances to continue growing. Either way, we can expect recurring booms and busts until our monetary approach is rebuilt on stronger policy principles.

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Wed, 07/02/2014 - 09:34 | 4917417 AccreditedEYE
AccreditedEYE's picture

Why waste so much time on this when, from the mouth of the Bernanke himself, you already heard there will never, EVER be rate normalization in our lifetimes? They've got this game "fixed".

Wed, 07/02/2014 - 10:01 | 4917457 SamAdams
SamAdams's picture

The FED may have to increase rates slightly to attract bond/T paper buyers from negative interest Euro-zone.  It has to be be more tempting than the private (stock market).  However, normally high rates are not to be seen in the remaining dollar reserve life.  This is the balance that they will not be able to achieve without making private banks insolvent or causing a loss of confidence due to Fed balance sheet.

Wed, 07/02/2014 - 10:32 | 4917650 nidaar
nidaar's picture

"remaining dollar reserve life"

that could just be months, if not weeks...

Wed, 07/02/2014 - 10:52 | 4917711 exi1ed0ne
exi1ed0ne's picture

You are assuming rational market participants are buying the paper.  In reality, we have nations like Belgium buying hand over fist - even surpassing their GDP.  If rates rise the dollar dies, since the national debt will be unservicable.  You will never see high rates again until the dollar replacement is born, if then.

Wed, 07/02/2014 - 16:44 | 4919134 daveO
daveO's picture

A dollar death would mean the banksters have lost control. Free markets would immediately return to pricing risk properly. Probably, at first, at incredibly high rates.

Wed, 07/02/2014 - 09:46 | 4917459 negative rates
negative rates's picture

They will end the Fed before rates are allowed to rise.

Wed, 07/02/2014 - 12:38 | 4918123 ThirdWorldDude
ThirdWorldDude's picture

I respectfully disagree. The Fed will raise interest rates simultaneously with cutting 6 zeroes from the FRNs, long after King Dollah is dead...

Wed, 07/02/2014 - 09:49 | 4917478 yogibear
yogibear's picture

When the US dollar crashes others control rates.

Wed, 07/02/2014 - 10:05 | 4917547 semperfi
semperfi's picture

Perhaps China already owns the FED and JPM ?

Wed, 07/02/2014 - 10:03 | 4917535 asking4it2k
asking4it2k's picture

The FED is delusional if they think they can raise interest rates.

The truth is until the government fixes these gigantic trade deficits the USA has, we will never see a real recovery. Amazing how these so called "expert" economists fail to see that.

Wed, 07/02/2014 - 09:40 | 4917425 Kreditanstalt
Kreditanstalt's picture

What "policy normalization"?  Rates will never rise unless such is FORCED by the collapse of confidence in the currency.

They can't lose control of interest rates.  They know that.  That's the Fed's raison d'etre...to print money.  If they ever allow rates to rise loads and loads of overleveraged governments, companies and entities go BANG...

They have no plans to "shrink their balance sheet" by "selling assets".......EVER.

Wed, 07/02/2014 - 09:37 | 4917427 youngman
youngman's picture

I agree..they cannot let rates go up....

Wed, 07/02/2014 - 09:38 | 4917430 semperfi
semperfi's picture

I've got $1000 that says that "eventually" coincides with global monetary reset.   What do you say Mr. Wiley?

Wed, 07/02/2014 - 09:39 | 4917432 Yen Cross
Yen Cross's picture

  Tyler when you publish articles like this you're doing Z/H readers a disservice. The policy makers(Fed.) read this stuff and back track on their agendas for tightening, hence prolonging the agony we've endured for 6 years.

  We need some super secret code so they don't know what we're really talking about.

Wed, 07/02/2014 - 10:05 | 4917545 MidwestJester
MidwestJester's picture

How about common sense?

Wed, 07/02/2014 - 09:39 | 4917433 _ConanTheLibert...
_ConanTheLibertarian_'s picture

Planning for something which is not going to happen is futile.

Wed, 07/02/2014 - 09:44 | 4917450 alien-IQ
alien-IQ's picture

didn't The Bernanke say something like "not in my lifetime" regarding when we'd see the fed hike rates? I'm pretty sure I read that right here at ZH.

Wed, 07/02/2014 - 09:45 | 4917453 firstdivision
firstdivision's picture

Get out your bell-bottoms and use 'jive turkey', as the late 70's/early 80's will be making a comback.

Wed, 07/02/2014 - 10:09 | 4917559 semperfi
semperfi's picture

Angel Flights and Dittos and Dolphin Shorts - oh my !

Wed, 07/02/2014 - 10:00 | 4917473 TeethVillage88s
TeethVillage88s's picture

You are so right President Obama

Ok

You didn't build that unemployment Rate - We did.
You didn't build that Inflation Rate - We did.
You didn't build that GDP Rate - We did.
You didn't build ZIRP - We did.

Predict where we go from here with no prior historical reference is EASY.

Rates Set by the Fed will never again reach 5%
rates set by Credit Cards and for Payday Loans will go as high as allowed by Law.

I predict some kind of Invasion by big money from overseas. Maybe not a Chinese Invasion, but that is one example that is already happening. Free Trade & ZIRP has strengthened big banks of all kinds. Inflation and Fed rate Hikes will be the result of the Invasion of Foreign Money or US Dollars in the US Economy

Foreign Direct Investment is already higher than Domestic Private Investment. The new numbers will be higher.

Wed, 07/02/2014 - 10:56 | 4917723 JR
JR's picture

In the good ol’ days that built the American Dream, the price of borrowed money, the interest rate, was one of the most important prices in the economy, a price interconnected to all other prices. The Fed’s monetary voodooism is a frontal attack on the entire price system; it is a claim by the likes of the world oligarchy, the Rothschilds and the Rockefellers, that the price system that built America’s private market system can no longer be trusted.

The Fed not only has broken America’s price system, but it has collapsed her economic system. As such, the dollar is rapidly losing its world reserve currency status.  And America’s middle class structure is growing poorer because of the theft of its savings, because of the seizure of its property via theft by the Fed oligarchy.

Norwegian oil executive, Oysten Dahle, stated the obvious - that the Soviet Union “collapsed because it did not allow [market] prices to tell the economic truth.”

Keynesianism is Marxism.

Wed, 07/02/2014 - 16:39 | 4919114 daveO
daveO's picture

+100

Wed, 07/02/2014 - 09:50 | 4917477 GoldenGeezer
GoldenGeezer's picture

Off topic, but

Jamie Dimon has throat cancer. Another reason to celebrate this weekend.

 

http://dealbook.nytimes.com/2014/07/01/jamie-dimon-of-jpmorgan-diagnosed...

 

Wed, 07/02/2014 - 09:56 | 4917501 yogibear
yogibear's picture

It's what happens when you sell your soul, try to appease him and become one of  Satan's soldiers. 

Wed, 07/02/2014 - 10:04 | 4917522 Dr. Engali
Dr. Engali's picture

Useless fucking article. I guess that 100 trillion in unfunded liabilities and the fact that that the last time the fed raised rates they blew up the derivatives markets means nothing to this guy. The Japanese 2.0 fed is never going to raise rates in a meaningful fashion. Everything beyond that point is moot.

Wed, 07/02/2014 - 10:02 | 4917528 buzzsaw99
buzzsaw99's picture

if they merely moved the ffr to 0.5% the stock market would crash and they know it

Wed, 07/02/2014 - 10:07 | 4917549 Spungo
Spungo's picture

Why would I take my economic advice from a guy who dislikes Megaman?

Wed, 07/02/2014 - 10:29 | 4917641 littlewoodenboy
littlewoodenboy's picture

Yeah. As long as there is a quadrillion dollars in derivative contracts out there, I cant see the FFR numbers moving much higher.

Wed, 07/02/2014 - 10:29 | 4917642 littlewoodenboy
littlewoodenboy's picture

Yeah. As long as there is a quadrillion dollars in derivative contracts out there, I cant see the FFR numbers moving much higher.

Wed, 07/02/2014 - 11:17 | 4917798 barre-de-rire
barre-de-rire's picture

déjà vu.

 

shit, they changed the code.

Wed, 07/02/2014 - 11:10 | 4917771 Calculus99
Calculus99's picture

I'm far from an economics expert so I don't understand how they can't raise rates because sometimes the economic conditions DEMAND a rate rise, and if not taken, the problems only get far worse down the line?

What then might force them to raise rates as the lesser evil?

 

Wed, 07/02/2014 - 16:36 | 4919104 daveO
daveO's picture

Only foreign abandonment of the dollar, which would cause hyperinflation. See Mexico, 1980's.

Wed, 07/02/2014 - 11:35 | 4917851 LostandFound
LostandFound's picture

The new normal is zero interest rates, get used to it guys! the bankers can squeeze more stealth tax from monetary inflation and fractional reserve lending, we still have blood left, their is still no uprising! 

Wed, 07/02/2014 - 16:34 | 4919102 daveO
daveO's picture

Right. When an article starts out with a false assumption, I don't read any further.

 

It stands to reason that when the Fed eventually lifts interest rates, we’ll see the usual effects. Stop, read no further!

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