The Fed shouldn’t try to save the world from Trump tariffs
Given its record, the risk is that the US central bank will do just that
After Donald Trump chose the nuclear option for delivering on his tariff threats, adding to fears of global stagflation, US Federal Reserve chair Jay Powell made clear the central bank is in no hurry to respond.
The market, however, is already pricing in four rate cuts this year, suggesting that soon enough the Fed will choose stimulating growth over controlling inflation.
Most economists accept these excuses and buy the Fed’s argument that when adjusted for inflation, its rates are still “restrictive”.
Compared with the easy money era of the last 15 years, when real rates turned negative for the first time, a real fed funds rate of around 1.8 per cent does look relatively high.
Compared with the norms before 2009, however, the rate is not very high and hasn’t been restrictive enough.
Ruchir Sharma Financial Times 7 april 2025
https://www.ft.com/content/3958488c-c83b-47a8-83fc-628ce2bc9724
The Fed chair said it’s time to adjust policy rates. But he didn’t say by how much, and that’s all that really matters now for bonds.
Before Powell even approached the podium, the market was expecting about 2.25 percentage points worth of easing to take the fed funds rate to around 3%-3.25%.
If longer-term borrowing costs are to continue declining, it will have to come from a reassessment of the Fed’s ultimate destination.
Longer-term rate expectations stem from a highly academic debate of the neutral rate of interest, or r-star
The neutral rate is that which neither fans nor restrains economic activity.
Up until recently, markets and policymakers largely thought that the long-run neutral rate was around 2.5% (or 0.5% “real,” adjusting for inflation at 2%).
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RE: En halv procents realränta? Orkar inte ekonomin med högre realränta än så?
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Yields on 10-year Treasury notes sit around 3.80%.
If you assume that the fed funds rate will be between 3% and 3.25% there really isn’t room for the yield on the 10-year note to move much lower.
That would take a meaningful reassessment of neutral.
Unfortunately, it’s impossible to estimate neutral in real-time with a high degree of confidence,
as Powell himself has noted in previous Jackson Hole lectures.
In 2018, he said that “the location of the stars have been changing significantly.”
In 2023, he used similar language: “As is often the case, we are navigating by the stars under cloudy skies.”
In practice, policymakers try to feel their way to neutral by moving slowly.
The New York Fed’s John Williams, one of the most famous academic r-star gazers, is skeptical that there’s indeed been a sizable move up in the long-run “neutral” rate, and I’m sympathetic to that view.
Many American households and businesses locked in ultra-low interest rates and amassed large cash hoards during the pandemic, which made them seem initially insensitive to the monetary policy medicine.
But it may not matter what the experts and pundits say at this point; the changing perceptions about neutral will be hard to undo. Policymakers will ultimately find their way to r-star ploddingly and empirically, meaning it could take years for the debate to be settled.
Even if the r-star doves are right, estimates of neutral may not fully return to 2.5% until 2027 or 2028. That means that the rally in Treasury notes may soon hit a wall.
Jonathan Levin Bloomberg 23 August 2024
RE: Det intressanta är inte när sänkningarna börjar, utan var de slutar.
Bill Dudley: I think r* is a lot higher than the Fed recognizes
With large fiscal deficits and strong investment demand for the green economy and advanced technology putting pressure on borrowing costs, the so-called neutral interest rate is likely to be higher than in the past, according to Summers.
“I think the Fed’s making a serious mistake by believing that the neutral interest rate is so low, and therefore is misjudging how restrictive any given level of policy is,” he said.
“And if you don’t have the right North Star, you don’t navigate very accurately.”
Bloomberg 23 August 2024
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