We think it is more useful to compare economics and interest rates in
- the period since 2007 in the U.S. (The Great Recession) with
- the period since 1990 in Japan (Japan’s 2+ lost decades) as well as
- the period after 1929 in the US (The Great Depression)
...because they are all periods of a ‘balance-sheet recession’ (or similarly, ‘secular stagnation’).
Many commentators and policy makers don’t fully appreciate or acknowledge this distinction from the more frequent ‘inventory-cycle’ type recessions.
There are so many parallels between these three that it is next to impossible to dismiss the comparison. (note: for a previous writing of ours on this topic, click here) Using this, there is an important lesson for the Fed to consider now in weighing whether to raise rates.
In the two charts below, we’ve offset US interest rates to Japan’s interest rates by 16 years to roughly align the major peaks in their respective main stock markets. The charts each cover a 27 year period. Other than the US lowering rates quicker than in Japan (Ben Bernanke’s main legacy), and Japan’s term rates starting the cycle in the 8%+ range, these charts are quite similar; interest rates steadily grind lower over a long period of time.
Soon after the ‘NOW’ line in the comparison below, Japan raised rates one time in August 2000 (top chart) from 0.0% to 0.25%, yet almost immediately, term interest rates crashed as the economy faltered. Within 7 months, the Bank of Japan had to lower short-term rates back to 0.15% in February 2001 (note: the US interest rate target is already at 0.125%, not 0%). As US short-term interest rate expectations are priced now (dotted blue line in lower chart), the market expects a continuous Fed raising cycle to about 3% in 2024. We continue to think that the Fed Funds rate will be forced to stay much lower than that over the next 10 years, and all rates across the yield curve will need to drop to reflect that.
But there is a more specific issue that the Federal Open Market Committee (FOMC) faces at their next few meetings. The FOMC have, for a very long time, predictably moved their policy levers in opposition to the state of macroeconomics. In taking a survey of economics now, the US economy could easily warrant a further easing of policy. Wage stagnation, output gap slack, global recession-level commodity prices, sub-target inflation, China’s slowdown in its early stages, the rest of the world’s central banks in an easing mode, and US production indicators showing weakness are each, by themselves, a good reason not to raise rates.
Yet, part of the FOMC is contemplating a ‘philosophical’ rate rise this year simply because the Fed funds rate has been near 0% for close to 7 years, and it somehow seems reckless to them to leave the rate low indefinitely.
Our suggestion to the FOMC as we approach these dates is to be extra careful, look at the historical comparisons, and don’t underestimate the trust the markets have for the FOMC to act rationally. We all expect the FOMC to act counter-cyclically; a rate rise now would be pro-cyclical, or making the problem worse. Anything FOMC members say after a ‘philosophical’ rate rise would greatly diminish its value. This comparison with Japan suggests that raising rates prematurely is detrimental and avoidable.