Federal Reserve Target Rate Remains Close To Neutral
By James Picerno | The Milwaukee Company | jpicerno@themilwaukeecompany.com
The Federal Reserve in last week’s policy meeting left interest rates unchanged at a 4.25%-4.50% range, and a repeat performance appears likely at the next meeting on Mar. 19, according to TMC Research’s Fed funds model.
The model currently estimates a neutral rate at 4.13% (Feb. 4), or just 20 basis points below the current 4.33% effective Fed funds (EFF) rate. The near alignment between the model estimate and EFF implies that the policy rate is roughly in line with a neutral rate, i.e., an appropriate given current conditions. (The model uses five factors to estimate an equilibrium rate: inflation, unemployment, real 10-year yield, GDP and the yield curve).
The recent decline in the spread highlights the recent change of monetary policy that previously was substantially tight to what has recently become at/near a neutral stance.
A key source of uncertainty for the Fed is how President Trump’s plans for tariffs will evolve and how economic activity and inflation will respond. Earlier this week the White House announced sharply higher import duties for Canada and Mexico, and moderately lesser tariffs for China. A day later the president halted the Canada and Mexico tariffs for 30 days.
The risk that the central bank is monitoring is the potential for higher inflation due to a sudden increase in the prices of imports. Canada, Mexico and China represent the leading importers for the US and so an overnight increase in prices due to tariffs is expected to translate into a one-time increase in inflation overall.
Some analysts speculate that the Fed may pre-emptively raise rates if it perceives that a tariffs-triggered rise in inflation is likely. But San Francisco Fed President Mary Daly downplayed the idea this week, telling The New York Times: The Fed does not “need to be pre-emptive at this point. We have policy calibrated for this economy and the one we expect to have, and we’ve got time now to be actively watching to see what else is done.”
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