Thread by @TimmerFidelity

With all the speculation about the Fed raising interest rates sooner than later, let's take a look at how past "liftoff" attempts by the Fed affected the markets, and how the Fed then responded. (THREAD)

There have been four major liftoff attempts since the Global Financial Crisis. The first was in April 2010, after an 80% run in the S&P 500. The Fed ended QE1, producing a three month, 16% drawdown for stocks, which forced the Fed to start QE2 a few months later. /2

The second attempted liftoff gave us the infamous taper tantrum in May 2013 (8% drawdown). The third was the actual liftoff in 2018, which ultimately produced a brief but scary 20% decline for stocks. And now we are in the early stages of the fourth liftoff attempt. /3

For each of these four episodes I show the forward curve at the beginning and at the end, to show who won the round (the market or the Fed). /4

In March 2009, after a 57% fall in the SPX, the forward curve signaled a 1.46% funds rate over two years. In April 2010, that forward curve had jumped to 2.17%. After the correction, the forward curve was down to 99 basis points (i.e., four fewer rate hikes priced in). /5

In May 2013, before the taper tantrum, the forward curve priced in just two rate hikes over the subsequent two years. Then Fed Chairman Ben Bernanke uttered those famous words and the curve added in four more hikes. /6

Despite the sharp rise in real rates in 2013, the curve did not un-price those hikes, although the market did force the Fed to continue QE3 for several more years. /7

Then in 2018 the Fed was finally able to bring rates back to neutral while also shrinking its balance sheet. But then it went too far (for the market’s liking, at least), and in Q4 of 2018 stocks went into a tailspin. /8

In August of that year (when the 10-year was above 3%) the forward curve priced in a terminal rate of 2.64%. By the end of the year after a 20% drawdown, the curve was pricing in rate cuts. /9

Now we are in the fourth liftoff episode. At the end of 2020 the forward curve priced in no rate hikes as far as the eye could see (2026). A few weeks ago the curve priced in a terminal rate of 0.87%; then, after last week’s FOMC meeting, that rate is now up to 1.17%. /10

I think the Fed is signaling an eventual liftoff to something resembling a more neutral policy. I think the market should have seen this coming a mile away, but clearly everyone was in the same reflation boat. /11

It’s my take that the Fed will normalize policy if and when the economy can handle it, no sooner. The current reset in the reflation trade(s) may eventually prove to be a buying opportunity. But the liftoff dance is just getting started, so patience is warranted for now. /END