Yesterday, Janet Yellen announced the first hike in the Fed Funds rate in eleven years from .25% to .50%. When asked about why the Fed decided to raise rates now, Ms. Yellen responded by suggesting that the “odds were good” the economy would have ended up overshooting the Fed’s employment, growth and inflation goals had rates remained at low levels. She then went on to state that it was a “myth” that economic growth cycles die of “old age.”

While such an optimistic outlook for economic growth was certainly welcomed by the markets, both of her statements expose the challenges that lie ahead for the Fed.

Tick-Tock, The Fed Starts The Clock

Ms. Yellen is correct in stating that economic growth cycles do not die of “old age.” It is historically the impact of an exogenous impact that ultimately slows economic growth rates into a recessionary cycle. What Ms. Yellen failed to explain is that historically it has been the “tightening” of monetary policies that have been the “exogenous impact” to the economic growth cycle. 

Looking back through history, the evidence is quite compelling that from the time the first rate hike is induced into the system, it has started the countdown to the next recession. However, the timing between the first rate hike and the next recession is dependent on the level of economic growth at that time. As I stated earlier this week:

“When looking at historical time frames, one must not look at averages of all rate hikes but rather what happened when a rate hiking campaign began from similar economic growth levels. Looking back in history we can only identify TWO previous times when the Fed began tightening monetary policy when economic growth rates were at 2% or less.

(There is a vast difference in timing for the economy to slide into recession from 6%, 4%, and 2% annual growth rates.)”