Source: Wall Street News
Author: Zhou Xiaowen

Will the US economy decline after the interest rate hike cycle ends? How will the market perform?

At the press conference after the Fed's interest rate meeting at the end of last month, Federal Reserve Chairman Powell said that current interest rates have reached a restrictive level, but the full impact of interest rate hikes has not yet been shown. Therefore, it is expected that interest rates will remain high for a long time, and interest rates will not be cut during the year.

Powell also mentioned that if there is data support, the Fed may raise interest rates again.

However, due to the recent moderate performance of US economic data, most of the market still anticipates that the probability of the Fed's “last plus” in September is not high.

However, regardless of whether interest rates were raised in September or not, the market has basically determined that high interest rates will remain high for some time. As the effects of interest rate hikes gradually become apparent, some economists expect the US economy to fall into recession.

In this month's report, J.P. Morgan Global Market Strategy MD Nikolaos Panigirtzoglou and others reviewed the past Fed interest rate hike cycle and pointed out that in the past 12 cycles of the Fed's interest rate hike, 7 followed or accompanied the economic recession; inIn these 7 interest rate hike cycles, the average recession began 5-6 months after the last rate hike.

J.P. Morgan discovered that on the eve of and after the last rate hike, stocks and credit will face pressure in the context of an economic recession and rise sharply in a non-recession context; the US dollar's situation is exactly the opposite: it rises in a recession context and falls in a non-recession context.

In contrast, there is no difference in the performance of bonds. Whether in the context of a recession or a non-recession, the last interest rate hike can cause US bond yields to fall and the curve steeper; at the same time, in the context of a recession, changes in the yield curve seem more obvious.

US stocks, credit spreads: fluctuating under pressure

To compare the impact of the recession caused by interest rate hikes on assets, J.P. Morgan looked at the changes in S&P 500, BBB-AAA credit spreads, 10-year US Treasury yields, 10Y2Y yield curves, and the dollar trade weighting index for one and a half years before and one year after the end of austerity. The results are as follows:

The main difference appeared near and after the last time the Fed raised interest rates.

Before the last rate hike, whether it was stocks or credit, the overall situation was relatively flat.But after the last rate hike, they are often under pressure. Instead of a recession, they will rise sharply.

The following chart also shows that compared with the average pattern of the previous Fed tightening cycle,The stock and credit performance of the current cycle has been more diversified over the past year and a half.However, despite this change, after considering the factors of the economic recession, stocks and credit did not actually change much from the level of a year and a half ago.

USD: recession rises

Similarly, the trend of the US dollar after the last rate hike was also different.The dollar rose against the backdrop of a recession, and the dollar fell against the background of a non-recession:

Similar to stocks and credit, in the past year and a half, the US dollar has been more volatile than the previous Fed tightening cycle, but after considering the factors of the economic recession, the dollar actually hasn't changed much compared to a year ago.

Bonds: Little to do with the recession

By contrast, whether there is a recession or not, there is little difference in the impact of austerity policies on bonds:

In the context of an economic recession and a non-recession of the Federal Reserve's austerity, the bond pattern seems quite similar, both before and after the last time the Fed raised interest rates.

US Treasury yields rose before the last time the Fed raised interest rates, and the curve flattened, while yields fell after the last time the Fed raised interest rates, and the curve became steeper. Despite this, the flattening/steepening of the curve appears to be more evident in the Fed's tightening cycle associated with the recession than in the non-recession tightening cycle.

New loans: Weakness points to recession

On the loan side, J.P. Morgan pointed out that in the cycle of interest rate hikes, the weakness in new loans is more likely to mean that a recession will occur:

Although the collapse and decline of loans often occur at the same time,However, in a cycle of interest rate hikes that did not trigger a recession, there was no collapse of loans.

The following chart shows the 3-month annualized changes in all bank loan stocks in the Federal Reserve H.8 report, and also includes data on household and business debt stocks prior to 1973. The red bar depicts the last rate hike in an austerity cycle that was not followed by a recession.

This picture shows thatAfter the last rate hike in the Fed tightening cycle, loan growth was hardly affected, and there was no recession.Given the weak credit generation in the US,This means the Fed is more likely to decline after the current tightening cycle.

Overall, the historical analysis above J.P. Morgan shows that in the past 12 Fed austerity cycles, 7 followed or accompanied the economic recession. In these 7 Fed tightening cycles, the average US recession began within 5-6 months after the last time the Fed raised interest rates.

For stocks, credit, and the dollar, the main difference comes after, not before, the last time the Fed raised interest rates. In contrast, there is no difference on the bond side: regardless of whether the Fed's tightening cycle closely follows or accompanies the recession, bond yields fell after the last time the Fed raised interest rates, and the yield curve steeped.

editor/tolk