Every Federal Reserve Rate-hike Cycle Creates Uncertainty

Whenever the Federal Reserve embarks on a round of rate increases, it’s a lot like shaking an overripe fruit tree.

That is the analogy of Federal Reserve moves offered by Alan Ruskin. Ruskin is a macro strategist at Deutsche Bank.

“A starting point should be that every #Fed tightening cycle creates a meaningful crisis somewhere.  This is often external but usually with some domestic (U.S.) fallout.”

Going back in history, the 2004-6 Fed tightening looked benign but the US #housing collapse set off contagion and a near collapse of the global financial system dwarfing all post-war crises. The late 1990s Fed stop/start tightening included the Asia crisis, LTCM and Russia collapse. When tightening resumed, the pop of the equity bubble. The early 1993-4 tightening phase included bond market turmoil and the Mexican crisis. The late 1980s tightening ushered along the S&L crisis. Greenspan’s first fumbled tightening in 1987 helped trigger Black Monday. This was before the Fed eased and ‘the Greenspan put’ took off in earnest. The early 80s included the LDC/Latam debt crisis and Conti Illinois collapse. The 1970s stagflation tightening was when the Fed was behind ‘the curve’ and where inflation masked a prolonged decline in real asset prices.

So what about now? The #fed funds rate stands at 1.50% to 1.75%. This follows a series of slow rate increases that began in December 2015. Before that rates were near zero. The degree of tightening might seem pretty tame, but Ruskin notes that it comes after a period of “extreme and prolonged” accommodation. Furthermore, it is taking forms that economists and investors don’t fully understand. The Fed’s swollen balance sheet will begin to shrink.

Where the U.S. rate cycle is relevant, he said, is that the Fed’s “past extreme external policy accommodation can no longer mask domestic issues. This includes valuation extremes like compressed credit spreads.” That could translate into trouble for foreign assets, Ruskin said.

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Separately, Federal Reserve officials said that they would be content to allow inflation briefly to run above their 2 percent target.

The two most commonly followed inflation indicators are the #Consumer Price Index and the #Producer Price Index. Year over year inflation as measured by the CPI has exceeded 2% every month since last September.  Furthermore, inflation as measured by the PPI has exceeded 2% every month since January of 2017.  The Fed has stated that instead of the CPI and PPI they follow the “core personal consumption expenditures index, which they say stands at 1.9%. (How convenient.)

Markets already have been pricing in a 95 percent chance of a quarter-point move at the June FOMC session.  And another increase is expected in September.

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