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Is the Economy Ready for a Rate Hiking Cycle?

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They say history repeats itself. But when it when it comes to the first interest rate hike since 2006, perhaps it doesn’t.

With the next Federal Open Market Committee meeting on Dec. 16 and the Federal Reserve’s recent minutes showing a hike in December is more likely than ever, Erik Weisman, chief economist at MFS Investment Management, examined whether today’s economy is ready for a rate hiking cycle.

“It’s a really interesting time for [the Fed] to be raising rates,” he said during a media event on Tuesday in New York.

Weisman looked at major economic indicators one month before first Fed rate hikes in the past – December 1986, March 1988, February 1994, June 1999 and June 2004 – compared with today.

First he looked at the nominal gross domestic product growth (GDP) year over year. Today, GDP growth stands at 2.9%, whereas the last several times the Fed raised rates, GDP was around 5% to 7%.

At its lowest, the GDP grew 5% year over year the quarter before the first Fed hike in February 1994. And at its highest, 7.6% year over year in March 1988.

Next, Weisman looked at the year-over-year change in the personal consumption expenditures (PCE) – the Fed’s preferred price metric – a month before previous rate hikes.

Today, the year-over-year PCE has grown 1.3% – compared with 1.9% in 2004, 1.2% in 1999 and 3.8% in 1988.

“That’s lower than almost all of the other times that we’ve raised rates,” Weisman said.

ISM Manufacturing, an index based on surveys of more than 300 manufacturing firms by the Institute of Supply Management, is “basically right at the 50-50 mark.”

Whereas, before the most recent rate hikes the ISM Manufacturing index was nearly 55 or higher.

Weisman next compared real durable goods shipments year over year.

“Durable goods, factory ores, industrial production, all that stuff looks like it’s kind of stalled,” he said.

Today, the year-over-year real durable goods shipments are down 0.7%. Quite different from previous hikes, when durable goods shipments saw increases of 4.3% in 2004, 4.7% in 1999 and 7% in 1994.

The U.S. dollar is another economic indicator that Weisman compared to previous Fed hikes.

The U.S. dollar is up 10.7% year over year today.

“We’re going to raise rates as the dollar, depending on how you want to measure it, is up quite strongly in the last 12 months,” Weisman said. “Whereas historically it tends to be flat issue or negative.”

In previous cycles, the dollar was basically flat (down 0.6% year over year) before the June 2004 hike and down 8.6% before the March 1988 hike.

“When was the last time that the Fed raised rates under these kind of circumstances? When was the last time the Fed raised rates when the balance sheet was $4.5 trillion? Or when we were at zero for seven years?” Weisman said. “…or when nominal GDP was lower than 3%? Or when global growth was as low as it is now, debt levels this high, decline in corporate earnings?”

The industry is desperate to look for lessons from prior cycles, but what Weisman is saying is “let’s not look to the past.”

“My sense here is that there aren’t anything for us to look at,” he said. “This is its own cycle. It’s different. It’s different in a whole slew of ways … we need to take this cycle on its own terms.”

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