The day after a rate hike, the 10-year yield traded down seven basis points, to 4.93% (more curve flattening). Stocks rallied. Technology led.
We've talked often about the parallels between the current environment and the late 90s boom.
And this rate hike yesterday gives us another point of comparison.
As we know, a technology revolution was underway in the late 90s, with the rapid adoption of the internet. Productivity was high. Growth was hot. Inflation was tame (relatively low). And the Fed juiced it with rate cuts, starting in 1995.
The stock market boomed in 95, up 34%. And up another 20% in 1996. The economy boomed, growing 3.8% in 1996, up from 2.7% in 1995.
Then, in March of 1997, Alan Greenspan raised the Fed Funds rate a quarter point, to 5.5%.
The reason the committee gave, in its own words: "persisting strength in demand, which is progressively increasing the risk of inflation imbalances developing in the economy that would eventually undermine the long expansion."
They hiked because the economy was strong and they were worried about what that strength might eventually do.
Compare that to what Warsh said yesterday.
He was asked how a quarter point helps when it can't reopen the Strait of Hormuz (i.e. a quarter point hike can't fix the oil supply disruption). Warsh said, the Fed can't affect any individual price, but it can "ensure that any change in relative prices don't broaden out, don't have second and third order effects." This is another, Greenspan-like hike based on what prices might eventually do.
Same argument, twenty-nine years apart.
So, what came next after the hike in 1997?
For eighteen months the committee pushed Greenspan to hike again as unemployment fell toward 4% and growth boomed. The Fed's models said that had to produce inflation. He refused, and told them why: information technology was raising productivity, raising the economy's potential growth rate, and unemployment could fall further than anyone thought without prices rising.
He was right. Inflation actually fell.
Still, the Fed held rates steady at 5.5%. But not just steady, at real rates (Fed Funds rate minus inflation) between 3% and nearly 5% — very restrictive policy.
None of it stopped the boom.
The economy averaged 4.6% quarterly annualized growth through the end of the decade. Stocks put up five consecutive double-digit years, averaging 26%. And inflation moved lower (not higher).
It turns out, the productivity gains from the tech revolution were more powerful than the Fed's restrictive policy.
Through those years, American productivity growth averaged about 2.7%.
Fast forward to today: since the release of ChatGPT in late 2022, it has averaged 2.5%.
The Fed Funds is now at 3.75% to 4%, against 5.5% then. And the real rate, after yesterday's hike, is positive, but at just 0.18%, against roughly 3%+ then.
So, we have a productivity rate that rhymes with the late 90s.
A policy rate nowhere near as restrictive as the one that the 90s boom absorbed without breaking stride.
And the AI-driven tech revolution is bigger than the internet.
