From December 1954 to December 1964, the Effective Fed Funds rate moved from just 1.2 to 3.7. Over this ten year period two recessions took place, yet it took over two years of rate increases from our current levels to cause an economic faltering. That means increases of only .67% per year caused the first recession of this period. We are on pace, as estimated by the market, for three quarter point increases per year as we stand. As the economy starts showing signs of strength, the Fed, depending on how dovish the new regime will be, may start making this a reality.
While 2.5 more years of rate hikes seems like ample time to prepare for such an incident, there is more at play. The Fed is now allowing it’s balance sheet to shrink. What this means is there will be less demand for Mortgage-Backed Securities as they retire from the Fed’s mammoth holdings. This could cause their yields to rise faster than anticipated and spreads could, and probably should, widen.
During this time, William Martin was the Chair of the Federal Reserve. He was famous for the oft used “take away the punch bowl” line, and that he did. During recessions though, he gave it right back. While this was a simpler time, with no sizable balance sheet to note, the same may apply going forward, only this time it could take even longer as investors and regulators feel out the impacts of relative tightening from both rates hikes and uneasing.