Rate shocks - a look at recent history
Originally published 10/04/2018 © 2021 Olson Research Associates, Inc.
A colleague at CSBS recently asked me if we would consider putting together a new workshop designed specifically to address Interest Rate Risk in a rising rate environment. No problem, I've put together several such workshops during my career. Then he cautioned, "Remember, some of these folks have up to ten years of experience yet have never seen a rising rate environment." That made me stop and think. While I had considered this before, it still seemed strange none-the-less. I've been experiencing the same sort of interaction with our bank clients too. It's common during ALCO & Board meetings to hear questions like these:
What will this rising rate period eventually look like? (i.e. how fast will rates rise from now on? what will the top rate be?)
We're doing initial stress-testing at +200bp changes in rates; is it realistic to continue to do this?
While obviously I don't know for certain the answers to these questions, I can give some food for thought. This current rising rate cycle is slow...painfully slow by historical standards. I gathered data from the last several rising rate cycles. I attempted to isolate specific periods of time over which rates, in this case Prime Rate, changed by +200bp (or close to that.) How long did it take for rates to rise that much? What was the rate at the end of that period? I think the data is eye-opening, especially to someone who hasn't ever experienced a rising rate cycle.
12/16/15 - 09/27/18 = 1016 days | +200 bp
This is the current rate cycle; it took 1016 days for Prime to move up +200bp to 5.25%. What should be very obvious is the number of days for this to occur is longer than any others listed here. It's more than twice as long as the rise in the late '80's when a move of +200bp took only 471 days. And with several more moves expected from the Fed over the next year, we know we are probably not yet at the top.
08/08/05 - 06/29/06 = 325 days | +200 bp
This was the second major part of an overall rising rate cycle that actually began back in June of 2004 when Prime Rate was at a "low" of 4.00% (Fed Funds @ 1.00%) This particular slice of time was at the tail-end of the rising rate cycle when Prime reached a peak of 8.25%. This is the time frame many of us are referring to when we say, "the last time rates were rising." Strangely enough, it was more than 12 years ago!
08/09/04 - 06/30/05 = 325 days | +200 bp
This was really part one (see part two above) of an overall cycle that ultimately saw Prime Rate move a total of +425bp over a two-year period. Prime was 4.25% for the better part of the summer of 2004 when it moved to 4.50% on August 9. This part of the cycle would ultimately see Prime hit 6.25%.
06/30/99 - 05/17/00 = 322 days | +175 bp
Y2K...remember that? What a strange time to think back to. From a market rate perspective, it was really odd. We toyed with a fundamentally flat, and even inverted, yield curve. Prime rate reached a level of 9.50% (Fed Funds = 6.50%) where it stayed until the first few days of 2001. The overall rate movement here was only +175bp.
03/23/94 - 11/15/94 = 237 days | +250 bp
Now we start to see that rates can change much faster. Prime Rate rested at a low of 6.00% for the latter half of 1992 and all of 1993. Then near the end of the 1st quarter of 1994 it started stepping up. The change was fast by today's standard, moving +250bp in eight months. The upward move actually continued another +25bp to 9.00% in February of the following year.
08/10/88 - 02/24/89 = 198 days | +200 bp
If 237 days seemed quick, obviously this one will seem much faster - by about 1.5 months. This is the second half of a larger rate cycle upward. This slice began with Prime at 9.5% followed by Fed movements of +50bp each four times in a row. By the end of February 1989 Prime was at 11.50%.
03/31/87 - 07/14/88 = 471 days | +200 bp
The climb to Prime Rate of 9.5% in July 1988 actually began more than one year prior. The steps up, totaling +200bp, took 471 days. While this is the 2nd longest time frame for a +200bp move, it is still less than one-half of our current time frame. This rate movement in the late '80's is a tale of two very different halves. This first slow period - followed by a much faster second half (see above). Something else quite unique happened during this time frame too. Prime actually dipped down from 8.75% to 8.50% on February 2, 1988 only to jump back past that, up to 9.00%, and then finally on to 9.50%.
08/05/83 - 05/08/84 = 277 days | +200 bp
This rates up shift of +200bp took place at the tail-end of what was a pretty wild-ride (see below). While the rate shift here seemed calm compared to the prior 6 years (1978-1982), it still was extremely fast by today's standards. From August 1983 to May 1984 Prime Rate moved from 10.50% to 12.50%. Even then it didn't stay there long; after only 2 months Prime moved up again to 13.00% by the end of June 1984. Double-digit Prime Rate in the "-teens", whoa!
02/01/82 - 02/18/82 = 17 days | +125 bp
Did you blink? Take a nap? Take a two-week (plus a weekend) winter vacation to the Caribbean? If you did you might have missed something. In less than one-month Prime Rate shifted up by +125bp from 15.75% to 17.00%. For those of you that don't think instantaneous shifts are "realistic", look no further. How would you like to have been the guy who decided he should "think-over" his rate lock for a week or two... oops!
04/23/81 - 05/22/81 = 29 days | +350 bp
Here's another extremely short time frame. However, it is not the short time-frame that is interesting, but rather the sheer magnitude of the change...+350bp! It took less than one month. According to economic data the "early 1980's recession" officially started a few weeks later on June 2, 1981.
08/21/80 - 12/19/80 = 120 days | +1050 bp
This is perhaps the most fascinating shift listed. Prime moved a whopping +1050bp...yes you read that correctly...+10.50%, from 11.00% up to 21.50%, and it only took 120 days to do it. Rate volatility was something of a "thing" around this time frame. Imagine making any sort of fixed-rate loan at this time.
02/18/80 - 04/02/80 = 44 days | +475 bp
In hindsight what makes this shift quite remarkable is that is shows rate volatility in 1980 was only getting started. This move of +475bp seems pedestrian compared to the months that followed (see above.)
07/26/79 - 11/16/79 = 113 days | +425 bp
If Prime Rate of 15.75% doesn't already give you an idea of how different an era this was, perhaps another benchmark rate will do the trick. Imagine a time when home mortgage rates hovered around 11.00% The 30-Year Fixed Mortgage rate started 1979 at 10.39% and finished the year at 12.9%. That level is very hard to imagine given today's competitive rates around 4.50%.
10/12/78 - 12/26/78 = 75 days | +200 bp
It seems that little economic news from the 1970's was positive - inflation (and stagflation), unemployment, embargos, etc. In October of 1978 Prime Rate was 9.75%. In a short period barely covering two and a half months Prime moved up +200bp to 11.75%.
All this historical behavior can't really tell us anything concrete about what's to come in 2019. I often hear people say, especially when talking about rates in the 1980's, that those conditions were quite unique and that they are not likely to happen again. “Things are different now,” they say.
Really? I lived through the 70's and 80's and I would say that our economic and political environments are every bit as dynamic (and perhaps even volatile) today as they were back then. I think to say “it can’t happen again” might be a bit too strong of a statement...but then, who really knows!