History Shows Fed Tightening Will Likely Lead To U.S. Recession

In December, the Federal Reserve finally began its first interest rate tightening cycle since the Great Recession. With the timing of the next rate hike now a hot topic of debate among traders, Goldman Sachs analyst Jan Hatzius took a look back at past tightening cycles and how often they resulted in recessions.

“With the labor market approaching full employment put payrolls still growing rapidly, the FOMC will eventually face the challenge of achieving a deceleration without inducing a recession,” Hatzius explains.

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Since 1945, the U.S. has had 12 major tightening cycles. Unfortunately, all but three of the tightening cycles resulted in a U.S. recession within two years.

Since 12 cycles is a relatively small sample size, Hatzius also looked at the impact of tightening cycles among all of the G10 economies as well. All together, there have been 116 instances of tightening cycles among the G10 since the Great Depression, and roughly half have resulted in recessions within the first two years. While this number is slightly more encouraging than the U.S. number alone, it still means that a recession could be a coin flip away for the U.S. between now and the end of 2017.

Perhaps one silver lining to the historical data is that many past tightening cycles began in response to inflationary shock, which was not the case this time. Goldman believes that, in this sense, the cumulative historical data paints an overly pessimistic picture of the current environment.