Interest-rate traders reckon that the Federal Reserve won’t have to raise rates again in this cycle. They may be wrong.
Here are some reasons why.
The short-term real neutral rate that underpins the US economy will reach 2.5% by the end of this year, according to researchers at the New York Fed. Given that average PCE inflation hit 3.7% in the second quarter, the Fed may be forced to tighten its policy benchmark to at least 6%.
The findings also suggest that the Fed will find it hard to cut interest rates as the market widely expects should the neutral rate remain sticky.
In that case, higher for longer may indeed turn out to be the Fed’s mantra.
The Taylor Rule rate, which is premised on a stable neutral rate, was already pointing to a higher funds rate.
The restrictive rate for the US economy is 6.55%, assuming a real neutral rate of just +50 basis points.
Neutral rate, popularly known as r*, is the rate which is consistent with an economy that is at full employment together with steady inflation.
In a recent blog post, researchers at the New York Fed led by Katie Baker contended that in the short-run r* “has increased notably over the past year, to some extent outpacing” the aggressive tightening done by the Fed in its current policy cycle.