Fed officials believe that a federal funds rate of 2.5% is neutral when inflation is at 2%

 Recall that prior to the financial crisis, the neutral rate was widely assumed to be around 4% -- 2% real (as embodied in the Taylor Rule) and 2% inflation.  

Fed officials need to drive wage inflation down to a range of 3% to 4%. This will require a rise in the unemployment rate to at least 4.5% to 5% from the current 3.7%.

The budget deficit is likely to be around 5% of gross domestic product in 2023. That is an abject performance when the economy is operating beyond full employment. 

The rise in short-term rates will cause the central bank’s income to fall from a profit of more than $100 billion in 2021 to a loss of more than $100 billion in 2023.

While it is hard to know precisely when the persistent red ink will be viewed as big enough to matter, a fiscal crunch and bond market turbulence seem inevitable at some point.

Bill Dudley Bloomberg 3 January 2023



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