Federal interest rate peak may still rise, and the market is almost unable to afford it.
On Thursday local time, The Federal Reserve's "big hawk" and St. Louis Fed Chairman Brad summarized by presenting a demonstration document that even under the relatively loose dovish assumption, the current Fed's policy interest rate has not reached "sufficient restrictive levels." This means that policy interest rates will need to be further raised.
Brad's document clearly shows that the restrictive interest rate range may be between 5% and 7% - under the dovish assumption, the restrictive level of interest rates will reach 5%, while under the hawkish assumption, the restrictive level will exceed 7%. But Brad also pointed out that if inflation drops in the coming months, the target area may be lowered.
Then, the market's expectations for the peak of the Federal Reserve's interest rate rebounded rapidly and sharply to more than 5%, and the forecast time for starting the rate cut in cycle after the economic recession was also delayed, and US stocks and US bonds fell in response.
Monetary Policy Rules —Taylor Rules
First of all, Brad introduced an introduction to Taylor Rules.
Since the 1980s, the Federal Reserve has basically accepted the "single rule" of monetaryism and regards determining the money supply as the main means to carry out macro-control of the economy. After entering the 1990s, one of the most important events in the field of macroeconomic regulation in the United States was that the budget balance case was passed.
Under the new fiscal operation framework, the federal government is no longer likely to stimulate the economy by expanding expenditures and reducing taxes, which has weakened the role of fiscal policy in implementing macro-control in the economy to a considerable extent. In this way, monetary policy has become the main tool for the government to regulate the economy.
Faced with a new situation, the Federal Reserve decided to abandon the implementation of monetary policy rules that have been regulating the money supply to regulate the operation of the economy for more than ten years, and use adjusting real interest rates as the main means to implement macro-control of the economy. This is the current "Taylor Rules".
In Brad's view, the formula of Taylor's rule can be expressed as:
where Rt is the target policy interest rate, R* is the actual policy interest rate;
π*=2%, that is, the inflation target of the Federal Reserve, πt is the inflation rate a year ago;
φπ is the reaction of policy makers to the deviation from inflation from the target;
ygapt is the output gap, and min (ygapt, 0) represents the policy decision of the FOMC Association must be based on the assessment of insufficient full employment level;
max means that the policy interest rate cannot be lower than 0.
Specific indicators
Brad pointed out that when output is at the potential level and inflation is at the target level, R* represents the appropriate real interest rate in the short term. R* has dropped significantly since the 1980s.
. For the inflation gap, FOMC's inflation target is determined based on its favored inflation indicator - the overall PCE index. The overall PCE index in 2021 is about 6%, and is expected to exceed 6% in 2022.
Brad here only considers using the core PCE index and the Dallas Fed revised PCE index. Both inflation indicators are currently below the overall PCE, thus indicating that the inflation gap is smaller than what is estimated with the overall PCE.
Brad pointed out that according to macroeconomics theory, policy makers should usually raise interest rates when inflation is higher than the target value, but according to Taylor's rules, the increase ratio is not 1:1. Past economic literature shows that in the case of doves, this ratio should be 1.25, and in the case of hawkish, this ratio should be 1.5.
Both assumptions point to - policy interest rates are far from reaching the limiting level
First, Brad used the dovish assumption, namely, 1. Use the PCE index revised by the Dallas Fed, 2. Set the actual interest rate R* before the epidemic to -0.5%, 3. Use 1.25 as a parameter to describe policy makers' response to inflation deviations.
For the hawkish assumption, Brad uses 1. The core PCE index as the inflation target, 2. The higher 0.5% real interest rate R*, and 3. Use 1.5 as a parameter to describe policy makers' response to inflation deviations.
Brad said that although the Fed's policy interest rate has increased this year, it has lagged far behind the growth of the target area (Recommended policy) in the chart. The target area clearly shows that under the dovish assumption, the limiting level of interest rates will reach 5%, while under the hawkish assumption, the limiting level will exceed 7%. If inflation drops in the coming months, the target area may be downgraded.
Brad also said that FOMC has raised interest rates by 75 basis points in each of the past four meetings. The transparency of interest rate hikes, and forward-looking guidance given by the Federal Reserve, seem to allow the interest rate level to transition to higher levels relatively orderly.
Brad pointed out that since the beginning of this year, policy interest rates have only been partially adjusted when deviating from the target level, which is the so-called "policy inertia", that is, keeping the interest rate level unchanged. This inertia includes FOMC's judgment on the rate of interest rate adjustment and its possible risks, and is weighed against the benefits of the balanced growth path that restores inflation to 2% as soon as possible.
Brad thus concluded that even under the relatively loose dovish assumption, the Fed's policy interest rate did not reach "sufficient restrictive levels."
market crashed
Brad's prediction about "the Federal Reserve needs further rate hikes" was released, Minneapolis Fed Chairman Kashkali also took a hawkish stance, warning that "there are not many signs of a cooling of demand at the moment."
comments believe that Fed officials expressed their statements that interest rate hikes are far from over, and that they are not close to the end of currency tightening, and warned that more pain is coming. In addition, the number of first-time unemployment benefits in the United States announced on Thursday unexpectedly declined but fell, approaching a historical low, highlighting that despite the Fed's continued aggressive interest rate hikes, the domestic labor market remains strong, making it more reasonable for the Fed, which is focusing on slowing economic growth and suppressing inflation, to raise interest rates further.
The market's expectations for peak interest rates quickly and sharply rebounded to more than 5%, and the forecast for the start of a interest rate cut cycle after the economic recession was also delayed. US stocks and US bonds fell on Thursday.
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This article does not constitute personal investment advice, nor does it take into account the special investment goals, financial situation or needs of individual users. Users should consider whether any opinions, opinions or conclusions in this article meet their specific circumstances. The market is risky, so you need to be cautious when investing. Please make independent judgments and decisions.
The peak Fed interest rate may still rise, and the market can no longer afford it
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