Get To Know The 'Fed Hike Handbook'

A new report by J.P. Morgan analyst John Normand assesses the impact of an imminent FOMC interest rate hike. Although Normand calls the first rate hike of the next tightening cycle “the most anticipated in history,” he believes that the fallout from the move will likely already be priced into global markets by the time the Fed pulls the trigger.

Macro Context

The last five Fed tightening cycles have lasted an average of 18 months each and have produced an average rate increase of 3.25 percent, or 0.20 percent per month. Normand notes that each of the Fed tightening cycles since 1983 has led to the collapse of a major asset market.

“In this cycle the Fed will be tightening into mild stagflation—perhaps the weakest growth but tightest labour market of any of the last five cycles,” he explains.

Bond Yields

According to the report, nominal 10-year rates begin climbing about four months prior to the first rate hike and rise an average of 1.50 percent throughout the duration of the cycle.

The current real U.S. 10-year rate has been lower at other times in history, but it has never been this low prior to the beginning of a Fed tightening cycle.

Currencies

The USD rallied during the tightening cycles in 1983, 1994 and 1999, but it did not strengthen during the cycles in 1986 and 2006. The current bull market for the USD is rising at three times the average rate during past tightening cycles.

Normand notes that weakness in emerging markets forex is typical throughout Fed tightening cycles.

Commodities

The performance of commodities has been inconsistent during past tightening cycles, although commodities have tended to trade inversely to the USD. Oil and copper have historically been the best performers during tightening and agriculture has lagged, but weakness in oil and relative strength in livestock seems to indicate that this cycle will be atypical.