137 basis points: smallest rate hike cycle in Fed history

The Fed has started its latest rate-hiking cycle.

Meeting market expectations, the FOMC raised the fed funds rate to 3.75-4.00% from 3.50-3.75% yesterday. After a hawkish Q&A session with Chairman Kevin Warsh, markets now see a roughly even chance of another rate increase in October. Still, many doves argue that inflation is transitory and will be quickly tamed. One reason for this is that the cycle began at a relatively high starting point, and the housing sector, the most rate-sensitive part of the economy, has been in a multi-year slump.

The forward curve implies three more rate hikes for a total of four, with a terminal rate of 4.50% to 4.75%.

Compared with history, that would be an outlier. The smallest hiking cycle on record occurred in 1986-87, when rates rose 137 basis points from 5.88% to 7.25%. The next smallest was a 1.75% rise in 1999-2000, which peaked at 6.50%.

Also worth focusing on is the 'End' column, which shows absolute levels. During the intense post-COVID inflation, the peak was 5.375%, supporting the dovish case for stopping rate hikes sooner. Even in that supply crunch, a rate range of 5.25-5.50% proved sufficient.

Thus, a terminal rate of 4.50% to 4.75% brings the cycle close to that threshold. Three more hikes would be equally aggressive, and currently such a reaction seems unwarranted. Of course, that could change if an endless war and $200 oil emerge.

A more likely scenario is some US fiscal restraint under a divided Congress and an end to the war. Given that, the market's thinking makes sense, but history does not support the curve's outlook.