Breadth Thrusts & Bread Crusts: The Fed's Still Playing Catch-Up

JC Parets
May 26, 2022

From the desk of Willie Delwiche.

The minutes from the May FOMC meeting were released this week, leading to renewed “will they or won’t they” discussions about potential rate hikes later this year. 

I’m old enough to remember when FOMC minutes weren’t really a thing. I liked it better then. I also preferred when Fed officials (both Board Governors and Regional Bank Presidents) were rarely seen, and even more scarcely heard. But I digress… 

When thinking about where rates have gone in the past and where they could go in the future, it’s helpful to remember the context of the Fed’s dual mandate (stable prices and full employment). The last three tightening cycles all began with lower inflation & higher unemployment rates than we have now.

Early 1999: The Fed began tightening with inflation at 2.0% and the unemployment rate at 4.2%. Rates would end up peaking at 6.5% in 2000 with inflation at 2.4% and the unemployment rate at 4%.

Early 2004: The Fed began tightening with inflation at 1.9% and the unemployment rate at 5.6%. Rates would end up peaking at 5.25% in 2006 with inflation at 2.6% and the unemployment rate at 4.6%. 

Late 2015: The Fed began tightening with inflation at 2.0% and the unemployment rate at 5.0%. Rates would peak at 2.25% in 2018 with inflation at 2.2% and the unemployment rate at 3.9%.

Early 2022: The Fed began tightening with inflation at 6.5% and the unemployment rate at 3.6%. Rates have risen to 0.75% so far, but are expected to be at 1.75% after the next two FOMC meetings (June and July). 

With the economy ostensibly stronger and inflation more prevalent than in the past, expectations of an abbreviated tightening cycle seems to be born more out of hope than wisdom. The Fed has already delayed raising rates as it waited to see if inflation was going to be transitory. I doubt they have the flexibility to do so again. Getting above the 2018 peak in rates seems like a minimum threshold for this cycle. If inflation stays high (above 4%) and the unemployment rate remains low (below 4%), peaks in previous cycles become more relevant targets. 

Bottom Line: Economic conditions are likely to feel the burden of higher rates. But with the Fed still in catch up mode, this is not the time for it to take a breather. 

P.S. Esther George, current President of the Kansas City Fed, announced that she will be retiring. The FOMC will miss her perspective. She had the courage to dissent from rate cuts in Summer/Fall 2019 when the yearly change in the median CPI was reaching its highest level in over a decade and approaching 3%. The seeds of our current inflationary period were being sown then (though they were well-watered and fertilized by the monetary and fiscal policy response to COVID).

P.P.S. An accelerated tightening cycle has implications for investments. Stocks have tended to struggle when the Fed is aggressively applying the brakes. This cycle has just begun, but the pattern appears to be holding. Commodities have tended to do well heading into these cycles in the past, with strength persisting into the second year after the initial rate hike. I don’t see evidence at this point of that pattern not holding.

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