The odds of the Federal Reserve being done with their interest rate hike cycle are being hotly debated in stock trading circles. Of course no one knows how things will turn out. Yet surprisingly, there are some indications that the central bank may be closer than many suspect to at least a pause.

Forecasting events in the stock market and the economy is usually a recipe for disaster. But looking at history and comparing the past to what’s going on in the present can be helpful, which is why in this article, I am reviewing what happened during the only economic “soft landing” engineered by the Fed in modern times (1994) and how it compares to what’s happening today.

I am basing this comparison on the fact that no matter how hard the Fed tries, the economic data points only to a slowing of the overall economy but not to a complete breakdown and recession.

By the time this article is published (May 4, 2023), the Federal Reserve will likely have raised the Fed funds rate for the 10 time since it began its current rate hike cycle in March 17, 2022. That means the Fed has been raising interest rates for 14 months.

The prevailing wisdom is that the rate increases will eventually lead to a recession. In my opinion, however, the Fed is more likely silently hoping that it may get away with the elusive soft landing in which the economy slows but it can avoid a full blown recession.

And since Mr. Powell likely fancies himself as a brilliant strategist, I would expect that he does not want an all-out crash. No one wants to be compared to Herbert Hoover.

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The stock market seems uncertain as to what’s likely to happen, which is why it oscillates, sometimes wildly on an intraday basis and often closes unchanged. At other times, it closes on the down side only to bounce back within one or two sessions.

The bottom line is that stocks have gained some ground in 2023 as measured by the S&P 500. The bond market seems to be forecasting a slowing of the economy in the not-too-distant future.

The Soft Landing

There was a soft landing in the U.S. economy in 1994-1995 while Alan Greenspan led the Fed. The table below shows the general course of the federal funds rate during that time period.

The fed funds rate is the target interest rate set by the Fed at which commercial banks borrow and lend their extra reserves to one other overnight.

Rates almost doubled with the fed funds starting at 3.25% in February 1994 and rising to 6% by February 1995. By July 1995, the Fed began to lower rates and was able to engineer the soft landing.

FOMC Meeting Date	Rate Change (bps)	Federal Funds Rate
Feb. 1, 1995	+50	6.00%
Nov. 15, 1994	+75	5.50%
Aug. 16, 1994	+50	4.75%
May 17, 1994	+50	4.25%
April 18, 1994	+25	3.75%
March 22, 1994	+25	3.50%
Feb. 4, 1994	+25	3.25%

Source: Forbes.com

Apples and Oranges

Inflation today is different from what Mr. Greenspan dealt with in 1994. Back then, it was a traditional monetary inflation where too much money in circulation was chasing too few goods. Certainly, today’s inflation shares some of those characteristics.

However, in 1994, globalization was in its early stages which meant that manufacturing capacity in the U.S. was still good enough to adjust production to meet demand once the Fed drained enough money from the system to bring things back to balance.

Today’s inflation is structural. During the past several decades, due to globalization, U.S. manufacturing capacity moved overseas, as did manufacturing jobs. That means that the supply side of the equation was hampered.

The net result is that when the Fed expanded money supply to counter the pandemic in 2020, there wasn’t enough capacity to counter the increased demand for products induced by the huge influx of newly created money.

That created a particularly sticky form of inflation that has been hard to tame via traditional methods of inflation fighting, such as raising interest rates.

On the other hand, since complex systems adapt, it is plausible to consider the fact that reshoring and onshoring (the return of U.S. manufacturing and jobs) is at least partially responsible for the resilience of the U.S. economy.

Consequently, the Fed has had to fight inflation on two fronts, the supply side, and on the side of rising costs incurred by companies moving their operations back to the U.S. in a period where supply chains have been disrupted and inflation has caused labor shortages leading to rising wages.

Recent private sector data from ADP showed an unexpected increase in U.S. jobs, even as JOLTS data suggests that job listings are crashing. The ADP headlines blared the gains in the hospitality sector (154,000) and healthcare (59,000). But more to my point was the increase in natural resources and mining (52,000) and construction (53,000).

To throw in another variable which the Fed has to deal with, as I’ve noted here many times, there is the ongoing population migration to the sunbelt, with its effect on housing, construction, and infrastructure which will continue to influence the data.

The Big Picture in 1994

Just as in the present, the reason for the Fed’s rate increases was the rise in the consumer price index (CPI), a sign that inflation was on the rise. The composite price chart below shows the relationship between the fed funds rate (main panel) to the CPI (bottom panel). The nearly 100% correlation between the two is quite visible.

On the other hand, the two middle panels (the S&P 500 – SPX) and the U.S. Ten Year note yield (TNX) illustrate how the stock and bond markets responded to the rate hikes during the period. You can see that SPX bottomed out in April and mounted a credible rally into September, when it began a significant decline. On the other hand, TNX rose along with CPI and the fed funds rate while eventually topping out in November.

Thus, the bond market is the proverbial canary in the coal mine. Specifically, when the direction of the fed funds rate and the direction of the Ten Year note diverge, it often signals that the rate hike cycle is close to ending.

The Current Situation

What we see today is similar activity to what we saw in the first half of 1994 in SPX, which has been in a trading range despite the Fed’s continued rate increases, even as CPI and the fed funds rate have continued to climb.

On the other hand, the U.S. Ten Year note (TNX), at least prior to the Fed’s actions on 5/3/23 seem to have rolled over with the 3.5% yield area offering a great deal of price chart resistance. That means that the bond market, at least prior to the Fed’s announcement and Mr. Powell’s unpredictable press conference, is betting that the economy is likely to slow as the Fed’s persistent rate hikes finally take hold.

The Bottom Line

If I’m right, the Fed is hoping for a soft landing. There are stark differences between the economy as it was in 1994 and the present. That means that the Fed’s rate hikes may not produce the effects it is hoping for. Depending on how all the contributing variables line up — onshoring/reshoring, the migration to the sunbelt, and the employment situation — we may get either a major recession, or perhaps another soft landing.

Specifically, it’s important to recognize that these secular megatrends, the population migration to the sunbelt states and the reshoring/onshoring of U.S. businesses, have created a different set of on-the-ground variables, reflected in the employment data which the central bank is either unaware of or doesn’t know how to handle.

Meanwhile, both the stock and bond markets are acting in similar ways to their 1994 responses to the Fed’s rate hike cycle.

If that pattern remains in place, then we may see a further decline in bond yields. How the stock market will respond, however, remains to be seen. This is due to the ongoing gyrations of the options markets and its relationship to stock prices.

My point is that we are dealing with complex, non-linear variables, which have not yet reached a point where the system is ready to move to its next level of operation. But as time passes, the odds of that event will increase. And we may be nearing that point.

Yes, forecasting is a fool’s game. But those who ignore history are bound to repeat it.

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