“For nearly six years, the Federal Reserve has held short-term interest rates at essentially zero to support the economy after the 2008 financial crisis. The severity of the Great Recession, and the Fed’s inability to lower interest rates below zero, led policy makers to use unconventional tools to stimulate the economy, such as quantitative easing (i.e., large scale asset purchases) and forward guidance. With strong employment gains and an improving economy, the Fed is now preparing the market for an eventual rate increase, perhaps as early as June 2015.
Considering the timing and potential magnitude of the Fed’s next tightening cycle, we thought it instructive to look at how financial markets have behaved in past cycles for clues as to what might happen when the rate cycle does eventually turn.”
Past fed rate hike cycles
“An exploration of past Fed tightening cycles starts with a review of how monetary policy adjustments work. One of the main tools Fed officials use to adjust policy is the federal funds rate. Whenever policy makers want to slow the growth rate of the economy and restrain inflation, they may raise interest rates, which is known as “tight”, “restrictive” or “contractionary” monetary policy. Conversely, whenever policy makers desire to spur the growth rate of the economy and increase the supply of money and credit, they lower interest rates, known as “easy”, “expansionary” or “accommodative” monetary policy.
Over the last 30 years, five different tightening cycles have taken place. As seen in the following chart, interest rates have steadily declined during this period, where the interest rate in the current tightening cycle has peaked at a rate lower than in the prior tightening cycle. This is largely attributable to the Fed’s success in maintaining a low inflationary environment since the late 1980’s.
The chart below lists the Fed’s five most recent tightening cycles, detailing the timing and magnitude of rate increases once policy turned more restrictive. A quick calculation shows the federal funds rate rose by an average of 2.7% in the past tightening cycles and lasted for approximately one year. The only exception was the 2004 tightening cycle.
While each tightening cycle has been driven by different factors, past history may provide guidance on what to expect when rates eventually do head higher. As the old adage goes, history doesn’t repeat itself, but it often rhymes.”
United States Fed Funds Rate
The Federal Reserve likes to keep the fed funds rate between 2-5 percent. It’s the sweet spot that maintains a healthy economy. Price increases remain below the Fed’s inflation target of 2 percent for the core inflation rate.
The fed funds rate reached a high of 20 points in 1979 and 1980. That was to combat double-digit inflation.
In 1973, inflation tripled, from 3.9 percent to 9.6 percent. The Fed only doubled interest rates from 5.75 to a high of 11 points. Inflation continued to remain in the double-digits through all of 1974, lasting until April 1975. The Fed kept raising the fed funds rate to 13 in July 1974, and then dramatically lowered the rate, reaching 7 1/2 by January 1975.
The all-time low was 0.25 percent. That’s effectively zero.
Before this, the lowest fed funds rate was 1.0 percent in 2003, to combat the 2001 recession. At the time, there were fears that the economy was drifting towards deflation.
The Federal Reserve kept the target range for its federal funds steady at 0.5 percent to 0.75 percent during its February 2017 meeting, in line with market expectations and following a 25bps hike in December. Policymakers noted the improvement in business and consumer confidence and the rise in consumer prices and said near-term risks to the economic outlook appear roughly balanced. Interest Rate in the United States averaged 5.81 percent from 1971 until 2017, reaching an all time high of 20 percent in March of 1980 and a record low of 0.25 percent in December of 2008.
In October, the most recent month for which data is available, the annual U.S. inflation rate was 1.6 per cent, and it hasn’t been above the two per cent threshold that the Fed like to see since 2014. So its hiking its rate in an attempt to nudge inflation higher.
« In the most expected policy decision in recent memory, the only real surprise was the move up in the FOMC members’ expectations for future policy, » TD bank economist James Marple said.
« The move up is a signal that the Fed has become more confident in the economic outlook and that inflation will increasingly track closer to the two per cent target. »
Wednesday’s news marks the first time the U.S. central bank has raised its benchmark lending rate in almost a year. It’s also the first time the U.S. central bank has had a higher rate than Canada’s since 2007.
Last week, the Bank of Canada opted to keep its benchmark lending rate steady for the 11th consecutive time, at 0.5 per cent.
Fed May Raise Rates Soon
The US economy is expected to continue to expand at a moderate pace and wait too long to raise rates would be unwise, Fed Chair Yellen said in prepared remarks to the Congress. However, the economic outlook and fiscal policy face uncertainty and monetary policy is not on a preset course thus any changes will depend on incoming data, Fed Chair added.
United States Fed Funds Rate | 1971-2017 | Data | Chart | Calendar. (n.d.). Retrieved February 28, 2017, from http://www.tradingeconomics.com/united-states/interest-rate