“The biggest rate hike since 1994.” That is how the vast majority of financial news outlets described the Fed’s 75 basis point (0.75 percentage point or three-quarter point) rate hike this week. 1994, 1994, 1994. Yet none of the coverage we encountered took the time to explain what was going on then—the simple fact that the Fed last undertook a 75 bp hike then was apparently enough for context. That is rather a shame, in my view, considering late 1994 was an interesting stretch with some parallels to today. There were also plenty of differences, so I won’t argue anything here is a blueprint or predictive, but a trip down memory lane can help dispel the notion that the Fed did something inherently and automatically destructive this week.
Like 2022, 1994 was a midterm election year under a first-term Democratic president whose polling numbers were on the slide amid a raft of political infighting—a phenomenon that, as Fisher Investments founder and Executive Chair Ken Fisher wrote in Forbes at the time, “weakens faith in our institutions” and spurs volatility.[i] The S&P 500 didn’t fall nearly as much in 1994 as this year, but it came close to a correction, and stocks seesawed hard all year before finishing mildly negative. Yet economic growth was robust and unemployment was low—by all rights, things that should have inspired cheer.
However, they mostly fueled angst. You see, inflation was low, but the Fed—with Paul Volcker’s battle against inflation still relatively fresh in the Board of Governors’ memory—worried it wouldn’t stay that way. They worried not about monetary excess, but supply and labor shortages. They saw a strong risk that the US economy simply lacked the capacity to produce as many goods as the populace demanded. They obsessed over a metric called capacity utilization, which essentially measures the amount of slack in heavy industry, worrying it was too high—that companies couldn’t raise output without incurring significant costs in new equipment and facilities, which supposedly risked driving consumer prices higher. So, to prevent supply shortages from driving prices higher, they started hiking rates in February.
The first three moves were a quarter point each. But capacity utilization kept rising, so the Fed moved to half-point hikes in May and August. Inflation stayed tame, but GDP growth didn’t abate, and capacity utilization inched higher still. So did commodity prices, with oil jumping over 45% from mid-February 1994 through that July.[ii] Soon, a new fear set in: that the Fed had lost its mojo. That its traditional levers no longer worked at stoking or cooling demand and it would watch powerlessly as supply-side factors and commodity prices drove inflation higher. It raised the specter of even more moves to come, which caused rate-hike fears to spike. As economist James K. Galbraith noted in an early-November New York Times op-ed: “Every piece of good news – for example, the rise in construction spending reported Wednesday – sends the stock and bond markets down in anticipation of a new increase in interest rates.”[iii]
The Fed was undeterred, unveiling its 75-bp hike on November 15—spurring a flurry of commentary. Biggest rate hike since 1981! the headlines went. In The New York Times’ most excellent “Times Machine” archive, there are seven—yes, seven—articles devoted to the immediate fallout, including the accompanying market volatility and the impact on borrowing costs. Pundits debated whether high inflation or the sure-to-come surge in unemployment was the greater evil, and everyone penciled in more rate hikes to come. Oh, and three weeks later, Orange County went bankrupt after a huge leveraged bet on falling interest rates imploded its investment portfolio.
Accordingly, by yearend, sentiment was in the dumps. Economic expectations downshifted, with some economists predicting a recession would arrive by 1996. Ken Fisher noted in Forbes that the vast majority of professional investors were bearish, along with about 9 of 10 mom-and-pop investors he talked to.[iv] People were gloomy about the toll rising rates had taken on American households and small businesses, including jacking up mortgage costs and putting loans out of reach for many. Many saw Orange County as the first of many municipal dominoes to drop.
But none of those worries panned out. After midterms delivered gridlock, political fears mostly subsided. GDP growth slowed to 2.7% in 1995 but reaccelerated in 1996.[v] Inflation stayed roughly in a 2% – 4% y/y range before decelerating in 1997 and 1998. Stocks boomed every year from 1995 through 1999. Living standards improved for countless people from coast to coast and in between. The dreary 1994 faded from memory, lost in recollections of “the 90s” as a start-to-finish boom.
Obviously, there are big differences between now and then. The inflation rate is the biggest. China’s start-stop emergence from COVID lockdowns—not to mention the pandemic’s broad impact on global production and supply chains—is another. And where stocks had a near-correction that year, they are in bear market territory today. The pain today, for the vast majority of folks, is far, far worse. But the underlying issue of the Fed trying to use monetary levers to battle supply-side inflationary forces—and giving the entire country a migraine in the process—rings true today, in my view. As do the forecasts for unending rate hikes and surefire economic trouble.
I don’t know what the future holds today. No one does. But the story of 1994 and 1995—along with myriad other historical episodes—shows us that extrapolating a set of negative conditions forward indefinitely is an error. Back then, the situation changed much faster than everyone anticipated. After jawboning about another big rate hike in December 1994, the Fed instead held off until February, when it did one last half-point hike. By summer 1995 it was cutting—but stocks didn’t wait for that to happen. When the Fed announced its first rate cut that July, the S&P 500 was already up 20.7% on the year.[vi] And remember: This was before the Fed began its dubious practice of hinting at future moves in “forward guidance.” Succumbing to all the fear that proliferated after the Fed’s big November move would have been a grave error.
History doesn’t repeat perfectly. Sometimes there is only a slight rhyme. But looking back at past situations that bear some similarity with the present can help you map out probabilities for the future, and a look at 1994 and 1995 shows the probability of disaster following a big Fed move isn’t 100%. It also shows things can shift much, much faster than the world seems to expect. Hopefully that is at least a nugget of encouragement as we head into summer.
[i] “Three’s the Charm,” Ken Fisher, Forbes, 9/26/1994.
[ii] Source: FactSet, as of 6/17/2022. Brent crude oil spot price, 2/18/1994 – 8/1/1994.
[iii] “What Rebound, Stupid?” James K. Galbraith, The New York Times, 11/4/1994.
[iv] “A Year of the Bull,” Ken Fisher, Forbes, 1/16/1995.
[v] Source: BEA, as of 6/17/2022.
[vi] Source: FactSet, as of 6/17/2022. S&P 500 total return, 12/31/1994 – 7/5/1995.
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