Every Fed tightening cycle ‘creates a meaningful crisis somewhere’

Federal Reserve rate increases are a lot like shaking an overripe fruit tree.

That’s the analogy offered by Deutsche Bank macro strategist Alan Ruskin in a note late Wednesday, in which he urged clients not to “overcomplicate” the macro picture.

“A starting point should be that every Fed tightening cycle creates a meaningful crisis somewhere, often external but usually with some domestic (U.S.) fallout,” he wrote.

To back it up, Ruskin offered the following history lesson:

Going back in history, the 2004-6 Fed tightening looked benign but the US housing collapse set off contagion and a near collapse of the global financial system dwarfing all post-war crises. The late 1990s Fed stop/start tightening included the Asia crisis, LTCM and Russia collapse, and when tightening resumed, the pop of the equity bubble. The early 1993-4 tightening phase included bond market turmoil and the Mexican crisis. The late 1980s tightening ushered along the S&L crisis. Greenspan’s first fumbled tightening in 1987 helped trigger Black Monday, before the Fed eased and ‘the Greenspan put’ took off in earnest. The early 80s included the LDC/Latam debt crisis and Conti Illinois collapse. The 1970s stagflation tightening was when the Fed was behind ‘the curve’ and where inflation masked a prolonged decline in real asset prices.

So what about now? The fed funds rate stands at 1.50% to 1.75% following a series of slow rate increases that began in December 2015, lifting it from near zero. The degree of tightening might seem pretty tame, but Ruskin notes that it comes after a period of “extreme and prolonged” accommodation and is also taking forms that economists and investors don’t fully understand as swollen balance sheet begins to shrink.

Also, he notes, the U.S. already has the highest two-year  , five-year  and 10-year  nominal yields in the G-10 world, a phenomenon last seen in the U.S. dollar boom cycle of 1983-’84, which also happened to see the U.S. uniquely pursuing big fiscal stimulus and tight monetary policy.

Ruskin said the “simple point” is that volatility, measured domestically by the Cboe Volatility Index  , or VIX, and more “externally” by gauges like the Deutsche Bank Currency Volatility Index, or CVIX, “will take on many forms, but has a strong pattern of following the Fed by 18-24 months when the Fed raises rates.”

As an example, Ruskin takes note of “a host of idiosyncratic stories in [emerging markets] that look to be largely tangential victims.”

Where the U.S. rate cycle is relevant, he said, is that the Fed’s “past extreme external policy accommodation can no longer mask domestic issues, including valuation extremes like compressed credit spreads.” That could translate into trouble for foreign assets, Ruskin said.

The fact that the dollar initially fell as the Fed tightened rates contributed to the notion that “this time is different” and that a benign hiking cycle was under way, he said. The dollar, as measured by the ICE U.S. dollar index , has since regained its footing, rallying strongly since mid-April and notching a series of 2018 highs.

So far, U.S.-specific risk, including apparent potential trouble spots like junk bonds, have held up well, he noted. That’s the rub.

“In current circumstances, this good U.S. asset news is actually bad news for select (overripe) assets abroad because it emboldens and frees the hand of the Fed to shake the tree more,” he said. “In this regard, U.S. dollar strength is finally tightening financial conditions in the U.S. a little, and is a necessary (but as yet not nearly sufficient) condition to slow the Fed down.”