FINANCE

However JUSTIN SCATTINI predicts the end of the cycle to finish with positive real rates and to be of a shorter duration than the previous two similar cycles.

The US Federal Reserve (‘Fed’) has begun its rate tightening cycle. The Fed has also ended its $US120 billion per month bond purchasing program.

Key characteristics of past Fed tightening cycles include: – Size: the seven cycles since 1982 Fed tightening cycles have averaged 2.59 per cent, with a range of 1.38 per cent (ended by the 1987 crash) to 4.25 per cent. The Fed’s dot-point forecasts project rates rising to at least 2.1 per cent in late 2024. US short rate futures and the two-year bond yield at 1.5 per cent imply a terminal rate of ~two per cent, so also a below-average cycle. – Starting Point: over the past seven cycles the starting point rate has averaged 4.4 per cent, with an extreme range of 0.1 to 9.5 per cent. In real terms (less inflation) the starting point has averaged 1.3 per cent, with the range only slightly narrower at -1.9 per cent to +4.6 per cent. The current starting point of 0.1 per cent is the equal record low, but the real rate of -5.9 per cent is the record low by four per cent! – Duration: tightening cycles on average last 15.7 months, with a wide range of four to 37 months. The last two cycles have been the longest by some margin at 25 months (Jun 04 to Jun 06) and 37 months (Dec 15 to Dec 18), with the prior range four to 13 months. The Fed’s forecasts project rates rising through at least Dec 24, or at least 33 months. – Peak: the rate cycle has peaked at an average 7.0 per cent, with a range of 2.38 to 11.75 per cent. In real terms the peak averages 3.5 per cent, with a range of +0.2 to 6.5 per cent. The Fed’s dot-points in late-24 point to a possible peak of 2.1 per cent, or 0.0 per cent in real terms. This would be a record low in both nominal and real terms over at least the past 60 years.

The Fed and markets are assuming this will be a smaller than average tightening cycle and almost the longest in duration, despite the record low starting point. The peak would be a record low.

This Fed tightening cycle begins with an economic backdrop not seen in the past 40 years. Inflation is at 5.2 per cent and wage growth is at 5.7 per cent. Money supply is rising at 13.1 per cent year on year and up 39.9 per cent from pre-covid levels. Unemployment is at a historically low four per cent. Very strong consumer and business fundamentals are powering the strongest US real GDP growth in 40 years, up 5.5 per cent. In short the US economy is booming.

By contrast, Fed policy settings are still at emergency levels. With the economy and Fed at different extremes, market expectations of a smaller than average cycle seem highly optimistic. By contrast, we expect this Fed tightening cycle to be larger than average, to end at positive real rates, and to be much faster than the prior two.

Justin Scattini is an authorised representative (no 427053) of Ord Minnett Ltd, AFS licence 237121. He can be contacted on 5430 4444. This article contains general financial advice only and does not consider your personal circumstances; you should determine its suitability to you. Before acquiring a financial product you should consider the relevant product disclosure statement. Past performance is not a reliable indicator of future performance.

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