Did Bullard undervalue?  Stifel economists say the fed funds rate may need to rise to 8%-9%

Did Bullard undervalue? Stifel economists say the fed funds rate may need to rise to 8%-9%

Buzz Update Did Bullard undervalue? Stifel economists say the fed funds rate may need to rise to 8%-9%

A day after a Federal Reserve official’s moving admission that interest rates may need to rise as high as 7%, analysts have come to an even more startling conclusion: That 7% still won’t be enough. raised to win the fight against inflation.

In a presentation on Thursday in Louisville, Ky., St. Louis Fed President James Bullard said a 5% to 7% federal funds rate target is what is needed to shift costs borrowing in an area sufficient to slow economic growth and produce a significant drop in inflation. In the wake of those estimates on Thursday, US stocks suffered their first consecutive losses in two weeks, the ICE US Dollar Index DXY,
Treasury yields soared and many parts of the Treasury curve showed worrying signs about the economic outlook.

However, investors took Bullard’s views with a grain of salt. The bond market stabilized, along with the dollar, early Friday until comments from a second Fed official, Susan Collins, triggered a sell-off in government debt in the afternoon. Meanwhile, optimism has returned to equities, with the three main DJIA indices,

end higher on Friday. Behind the scenes, some economists applauded Bullard for his honesty, while other analysts said his estimates weren’t as shocking as investors and traders believed. One of the most underestimated risks in financial markets is that inflation may not fall back to 2% fast enough to mitigate the need for more aggressive action from the Fed, traders, money managers said. funds and economists at MarketWatch.

Read: Financial markets raced again with the tale of ‘peak inflation’. Here’s why it’s complicated.

Stifel, Nicolaus & Co. economists Lindsey Piegza and Lauren Henderson said they believe even a 7% federal funds rate could “underestimate” the level at which the US benchmark interest rate Fed should probably go up. The calculations show that there is a possible need “for a federal funds rate potentially 100 to 200 basis points higher than [Bullard’s] upper limit suggested,” they wrote in a note. In other words, a federal funds rate that is between 8% and 9%, compared to its current range between 3.75% and 4%.

“The recent improvement in inflationary pressures after peak levels has in some ways seemingly blindsided many investors as to the need for the Fed to continue aggressively on the path to higher rates,” they said. “While a 7.7% annual gain in the CPI [or consumer price index] is an improvement from the previously reported 8.2% annual pace, little cause for celebration or a clear signal for the Fed to move to a looser policy with a 2% target range still an achievement distant.

The Stifel economists also said that Bullard relies on a historically low neutral interest rate, or theoretical level at which the Fed’s policies neither stimulate nor restrict economic growth, within its assumptions.

Piegza and Henderson are not alone. In an unsigned memo, UniCredit researchers said that while “7% was downright shocking” to financial market participants, the idea of ​​a federal funds rate that ends up being much higher than what most people expect is “not particularly new”.

On Friday, fed funds traders mostly expect the Fed’s main policy rate target to be between 4.75% and 5%, or between 5% and 5.25%, by the first half of the year. next year. However, standard interpretations of the so-called Taylor rule estimate suggest that the federal funds rate should be around 10%, according to UniCredit researchers. Taylor’s rule refers to the generally accepted rule of thumb used to determine where interest rates should be relative to the current state of the economy.

Some have openly questioned the estimates made by Bullard, a voting member of the Federal Open Market Committee this year, noting that the policymaker omitted the impacts of the Fed’s quantitative tightening process in its rate estimates.

Once the QT process is taken into account, the “inner range” of potential outcomes for the fed funds rate “is likely closer” to 4.5%-4.75% to 6.5%-6.75%, said Mizuho Securities economists Alex Pelle and Steven Ricchiuto. The “full range” of plausible outcomes is even wider, however, and could be anywhere between 3.25% and 3.5% “on the ultra-dovish side, in which case the Fed is already over-tightening”, and 8.25%-8.5% “on the ultra-hawkish side, in which case the Fed is only halfway there.”

Chris Low, chief economist at FHN Financial in New York, called Bullard’s presentation “wonderful” because “it is the most honest attempt to convey public expectations of terminal federal funds within a reasonable range offered by an FOMC participant to date”.

“Remember he did everything he could to avoid shocking the market,” Low said of Bullard. “His zone is dovish to reasonable, not dovish to hawkish. Our expectations are always managed. We can’t blame him. »

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