High Rates Maybe Forever
Potentially limiting the central bank’s ability to cut and thus setting up a headwind for bonds is the growing view in markets that the economy’s so-called neutral rate is much higher than policymakers are currently projecting.
“The significance is that when the economy inevitably decelerates, there will be fewer rate cuts and interest rates over the next ten years or so could be higher than they were over the last ten years,”
said Troy Ludtka, senior US economist at SMBC Nikko Securities America, Inc.
Forward contracts referencing the five-year interest rate in the next five years — a proxy for the market’s view of where US rates might end up — have stalled at 3.6%.
While that’s down from last year’s peak of 4.5%, it’s still more than one full percentage higher than the average over the past decade and above the Fed’s own estimate of 2.75%.
If the market is right that the neutral rate – which cannot be observed in real time because it’s subject to too many forces – has permanently climbed, then the Fed’s current benchmark rate of more than 5% may be not as restrictive as perceived.
Indeed, a Bloomberg gauge suggests financial conditions are relatively easy.
The performance of financial markets also suggests the Fed’s policy may not be restrictive enough.
Most policymakers are moving to the camp of higher neutral rates. But their estimates varied in a wide range between 2.4% to 3.75%, underscoring the uncertainties in making the forecasts.
Bloomberg 23 June 2024
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