I have posted several times about Jerome Powell’s stated intention of bring the fed funds rate to “neutral,” which will neither stimulate nor slow the economy.
There are two widely watched inflation measures: the Consumer Price Index (currently 9.1%) and the Fed’s preferred measure, the Personal Consumption Expenditures Price Index, which is 6.3%.
Even after yesterday’s 75 basis-point increase, the fed funds rate is only 2.25%-2.5%. The June Fed median forecast is 3.25%-3.5% by 1Q2023. Unless inflation falls sharply, this will still be a negative real yield.
The bond market is predicting a recession by next year that will cause the Fed to go back to its “Fed put” strategy of cutting the fed funds rate at the first whiff of recession. Powell says he won’t cut if inflation is still high, but the bond market doesn’t believe him. The bond market is predicting falling rates after next year. The Treasury yield curve has been falling for the past couple of weeks.
The real fed funds rate is way below zero. The Fed is still paying borrowers to borrow money. This is stimulative, not a “neutral” rate.
As I posted earlier, the 1970s Fed did cycles of raise – lower – raise – lower three times. Each time, inflation came roaring back. It wasn’t until Paul Volcker decisively raised the fed funds rate above inflation in 1980 that inflation was quelled, at the cost of the difficult recession of 1980-1982 which at the time seemed like it would never end.
It’s nice to see that the Wall Street Journal Editorial Board has just published an editorial saying essentially word-for-word the same thing.
The WSJ didn’t mention the Treasury (which, of course, is separate from the Fed). The Treasury uses an internal (bogus) inflation number to report positive real yields on Treasury bonds. I don’t know why someone doesn’t slap the analyst upside the head since anyone can look up inflation rates from the neutral agencies (BEA and BLS). Even a child could subtract the 10 year yield from inflation and see that it’s negative. Whom do they think they are fooling?
The most important Macroeconomic factor in the U.S. is the fed funds rate since all other interest rates are pegged to it.
For investors, the most important question is whether the “Fed put” is still the rules of the game, or whether the Fed will actually fulfill its mandate of stable prices regardless of what the asset markets do.
If the Fed were to raise the fed funds rate to a true positive real yield, the 10% of listed companies that are zombies (barely able to pay the interest on their low-interest loans) would default when they needed to roll over their debts.
It would be carnage.