In his post-FOMC press conference on September 17, Fed Chair Jerome Powell stated that Fed policy remains tight notwithstanding the latest rate cut: “What we can say is this, that over the course of this year we've kept our policy at a restrictive level—and people have different views—but a clearly restrictive level, I would say.” In other words, monetary policy remains tight.
In his post-FOMC press conference on September 17, Fed Chair Jerome Powell stated that Fed policy remains tight notwithstanding the latest rate cut: “What we can say is this, that over the course of this year we've kept our policy at a restrictive level—and people have different views—but a clearly restrictive level, I would say.” In other words, monetary policy remains tight.
How does he know this? Real GDP rose 3.8% (saar) during Q2 to a record high, and it is on course to increase 3.9% during Q3, according to the latest estimate of the Atlanta Fed’s GDPNow tracking model (chart). The major stock market indexes are at record highs. S&P 500 earnings is at a record high. Gold is at a record high. True, the labor market is sending mixed signals, but that’s mostly related to structural labor supply issues, as we’ve previously discussed.
According to the FOMC's Summary of Economic Projections (SEP), the committee’s average view is that the neutral “long run” federal funds rate (FFR) is 3.0% currently (chart). The FFR is currently 4.0%, which is deemed to be restrictive. By the end of the year, the committee, on average, expects that the FFR will be lowered to 3.6%, which is less restrictive. Then it goes down to 3.4%, 3.1%, and 3.0% in 2026, 2027, and 2028, respectively.
That’s a long way to Tipperary. But it is consistent with the SEP’s goal of getting the inflation rate down from 3.1% at the end of this year to 2.6%, 2.1%, and 2.0% (i.e., the Fed’s long-run inflation target) over the next three years (chart).
Got that? The Fed doesn’t expect to hit its long-run inflation and FFR targets until 2028! They reckon that they will have to keep the FFR restrictive (i.e., above the 3.0% neutral rate) to get inflation down to their 2.0% inflation target by then.
We’ve said this before: The concept of a “neutral” FFR is just plain weird. Powell and other Fed officials have often acknowledged that it can’t be observed. It can only be estimated with econometric models, according to them. They also admit that it isn’t a fixed value and is likely to change over time. Indeed, the FOMC’s estimate was 2.50% in late 2023. Now it is 3.00%. And by the way: The latest Dot Plot shows that the range of estimates of its value is from 2.50% to 3.75% (chart)!
The bottom line for us is that the notion that there is a neutral overnight bank lending rate is ridiculous. Nevertheless, if we must play the game, we would say it is currently closer to 4.00% (where it is now) than to 3.00%. In other words, our Paradise Lost has been found at the current level of interest rates.
