Uncharted Territory in the Fed Funds Rate Cycle

It’s now been nine years since the Federal Reserve last raised the fed funds rate. The speculation grows by the week about when the first rate hike since 2006 will occur. Every economic data point that gets released is immediately put into terms about what it means for the potential for a rate hike.

I decided to look back at the past fed fund rate cycles to see how the current drought between rate increases stacks up historically. Federal Reserve data on the fed funds rate only goes back to the start of 1956, so we have around 60 years’ worth of data to work with. This table show each rate hike cycle along with the length of time it took to see another rate hike by the Fed to start the next cycle*:

Fed Funds Rising

The most striking thing about this data to me is how short these cycles have been. In this period, the longest the Fed waited between rate hikes was nearly five years, from 1989 to 1994. The average time in-between past rate hikes was just under a year and a half. So everything Fed-watchers have been saying for the past few years seems to apply. We’re in uncharted territory. It’s unprecedented monetary policy. The Fed is (possibly) behind the curve.

Finance people hate to admit this, but this time really is different. The recession was more severe and the recovery has been slower than we’ve seen in some time. Therefore, there’s not much of a post-WWII precedent for comparison purposes as the current business cycle is unlike any we’ve seen in this time. This is why economists and investors have had such a difficult time handicapping what’s going on with regard to economic growth and the path of interest rates. It seems everybody has been applying models that aren’t relevant to the current situation.

Many investors have pointed to the fact that stocks have tended to perform just fine during past periods of rising interest rates, which is counter-intuitive to financial theory. What most people fail to realize is that the biggest reason for this outcome is probably the fact that rates have risen in the past quite often. Take a look at the historical graph of the fed funds rate courtesy of FRED:

Fed Rate

Using the data in the table above, I calculated that the Fed was in the process of raising rates for almost 24 years during this time. That means 40% of the time the fed funds rates was actually in a rising rate environment since 1956. Considering that stocks are up roughly 75% of the time, you would expect some of the overall rise in stocks to come during periods of rising rates since they’ve occurred so often.

Many investors are quite nervous about the potential for a rising interest rate environment. It’s a legitimate concern, but I imagine most investors don’t realize how often the Fed has risen rates historically. The longer we’re forced to wait for the inevitable first rate hike from the Fed, the greater the speculation will become on the path that interest rates will take when it finally begins.

It’s an intellectually stimulating exercise to guess what the Fed will do next. Using history as a guide isn’t going to be much help from here on out.

Further Reading:
What Happens to Stocks & Bond When the Fed Raises Rates?
When Will the U.S. Have Its Next Recession?

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*I measured each cycle in this data set from the first rate increase to the next rate decrease.

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What's been said:

Discussions found on the web
  1. edinvestor1 commented on Jul 06

    Marty Zweig used to have a 2 steps and a stock market stumble rule on Fed raises. Considering the true number of unemployed, when the give ups are included, and the marginal interest in home buying, even with low interest rates, will the first rise crush the market and the economy or will tradition prevail? How about a comparison to rate increases in the 1930s?

    • Ben commented on Jul 06

      I’ve heard Zweig’s book is great and have been meaning to read it. I couldn’t find the data going back that far. I’ll see what I can do.

  2. Mark Massey commented on Jul 06

    Why have the 4 longest waits to the next rate hike all occurred since 1985?

    • Ben commented on Jul 06

      Maybe a coincidence, but Greenspan was name Fed chair in 1987…

    • TheDailyGold commented on Jul 06

      Because of a continunous increase in debt & weaker economy overall. Its so bad that they can’t even raise rates 6 years into a “recovery.”

    • John Richards commented on Jul 07

      My first thought is that is roughly the time globalization and wage arbitrage began, along with productivity gains from use of the PC. I think of Globalization as a 40-50 year process from 1985 to 2025/35, with 10-20 years to go before wage differences are again offset by the many costs of staging production so far from end customers… and Congress finally decides to do something about our disadvantageous Corporate Tax rates. With respects to Minyanville, we’ve seen mighty disinflation in things we want (TV, Car, Tech of any kind), but inflation in things we need (healthcare, education). Until wages and related costs hit some sort of equilibrium, I think employment and the US economic landscape will continue to endure a high rate of change. My 2 cents.

      • Ben commented on Jul 07

        The inflation/deflation saying was always one of my favorites from Todd Harrison. I’m o the belief that technology/globalization are only going to speed the future cycles up so everything happens much faster than in the past. I think we’re on the same page there.

  3. TheDailyGold commented on Jul 06

    The best comparisons policy & equity wise are probably 1937 and 1948. The Fed did QE in the 1940s and slowly changed policy in the late 1940s after a spectacular rally, similar to post 2009. They raised rates from 1% in 48 to 2% in 53. In 1937 they didn’t raise rates but did other things to tighten policy. Of course the late 1940s was after a period of volatile inflation. Considering what the Fed & gov will have to do to support the economy during the next recession, volatile inflation is likely ahead and not behind us. Of course no comparison is perfect.

  4. MrRFox commented on Jul 07

    Never before has anyone (big) tried to raise rates (from 0%, for Christ’s sake) when most all of the world’s other big players were firmly rooted in ZIRP – that’s what’s different this time.

    • Ben commented on Jul 07

      Very true. We live in interesting times, to say the least. I have a feeling this period of time will be studied for years to come.

  5. Peter Lazaroff, CFA commented on Jul 08

    Great stuff, as always. I was trying to reconcile the data for your rate hike periods with a monthly data download from FRED, but they don’t necessarily match up. If it isn’t too much trouble, would you mind explaining your methodology for determining the first rate hike and last rate hike?

    • Ben commented on Jul 08

      Shoot me an email and I can send you my data.

  6. Be Not Afraid | Bason Asset Management commented on Dec 14

    […] piggy-backing on some research my friend Ben Carlson did earlier this year in a piece titled “Uncharted Territory in the Fed Funds Rate Cycle.” Ben did the heavy lifting of identifying every rate increase period of the last 50+ years. […]