Over the last few weeks, several positive economic data have begun to lay the groundwork towards accomplishing the rare feat of avoiding a recession during a Fed tightening campaign. This favourable data includes falling inflation, cooling labour and wage data, a bottoming of global manufacturing data, and a steadying of central bank policy. Back in April, the Fed had predicted a “mild recession” but stated the recession would be “neither deep nor prolonged.” However, in the July press conference following the latest rate hike, Federal Reserve Chair, Jerome Powell, said that the central bank’s staff are no longer forecasting a recession. Moreover, when asked about inflation, Powell revealed that the Fed has “seen the beginnings of disinflation without any real costs in the labour market.”  This implies that the Fed is hopeful to thread the needle between cooling the economy without causing substantial layoffs and shock to consumers. For a fed that has professed to be “data dependent,” the latest data seems to suggest that the central bank could be at the end of its current rate hiking cycle. As Philadelphia Fed President, Patrick Harker, said in a speech, “I believe we may be at the point where we can be patient and hold rates steady and let monetary policy actions we have taken do their work."

Powell has professed that monetary policy could still be bumpy, and there are unlikely to be rate cuts anytime soon. Still, investors can interpret the latest developments as a market that is at or approaching peak rates. Below, we look at the historical data on the trajectory of the economy and stock markets around peak rates.

For those Fed tightening cycles that ended with a recession, it took on average 5-6 months between the last Fed rate hike and the start of the US recession. In the earlier cycles between the 1960’s - 1980’s, inflation was more rampant, and recessions generally occurred before or shortly after the last rate hike. However, in more recent cycles, recessions began much later, on average 15 months after the last rate hike. Given the current cycle’s prevailing inflation backdrop, history would suggest a shorter gap between peak rates and recession. However, the most recent economic data remains consistent with a relatively low risk of a near-term downturn. Should this resilient data persist, history will mark this fed tightening cycle as one that did not lead to a recession. This has occurred 5 of the last 12 fed tightening cycles.

As for stock markets, equities tend to trade flatter in the immediate period leading up to the last rate hike. For those cycles that ended in a recession, the S&P500 exhibited muted price action with higher volatility. In non-recessionary outcomes, the S&P500 resulted in strong rallies. On average, both recessionary and non-recessionary outcomes resulted in higher market levels 52 weeks (1yr) after the last rate hike. See the chart below. Although the current cycle appears to be in line with the historical averages, the S&P500 has experienced more volatility relative to historical paths. Hence, it would be reasonable to presume this volatility would continue in a post-peak rate environment.

With recessionary fears fading, many asset classes have priced out (i.e., removed) the prospects for a recession in the near term. Moving forward, the outlook for equity markets will depend largely on how well the economy holds up in an environment of higher rates. Most economic indicators continue to suggest the expansion is likely to stay intact in the near term. The outlook for long-term investors has improved, however, the difficult task at hand is to remain calmly invested amidst seasonal volatility and any knee-jerk reactions to data releases that miss expectations.