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By New_Deal_democrat February 20, 2018 9:27 am
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How much must interest rates spike for the economy to roll over?
Interest rates are the most potent background long leading indicators. Last week I wrote that I did not see them as having risen enough at this time to cause a recession, and noted that I thought they had to rise to at least about 3.25%, and for a sufficient period of time.
 
Here's why.
 
The below is a graph of 10 year treasury yields over the last five years, minus 2.6%, so that a 2.6% yield shows as zero:
 
 
Note that the 2013 "taper tantrum" caused yields to rise over 2.6% for about 1 year, from midyear 2013 to midyear 2014, and to a maximum of just over 3%. While housing slowed down substantially, the market did not roll over and there was no recession.
 
We have just in the last few weeks penetrated the 2.6% level.
 
The below is the same graph for the late 1960s, minus 4.5%:
 
 
It was only once interest rates rose 1.75% by early 1969, and rose even higher thereafter, that the housing market rolled over, and a recession began at the end of the year.
 
The late 1960s, like today, featured an outsize generation of young adults creating a tailwind in the housing market. It also featured "guns and butter" fiscal policy, in which both marked increases in both military and domestic spending created significant budget deficits, even in the face of a good economy. It is thus a very good match for our current situation.
 
So, for interest rates to cause the economy to roll over now, it would probably take an increase  interest rates by at least 1.75% from their lows of roughly 1.5% -- i.e., up to 3.25%. After one year of this in 1969 the economy actually entered a recession. But because interest rates act upon the economy with a lag, we probably only need about 6 months or so of rates at the heightened level in order to knock the economy down.
 
Finally, note that even if we hit 3.25% interest rates on the 10 year treasury today, and interest rates stayed at that level, it would normally take at least a year -- i.e., into spring 2019 -- before I would expect a recession to begin. 
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