Chart of the Week: Getting Closer to Neutral

Chart Getting Closer to Neutral
Since the Federal Reserve began raising short-term interest rates in 2015, there has been substantial debate about how far they would go during this tightening cycle. The expectation has been that they would try to raise the fed-funds rate to be at least in-line with their projection of the neutral rate, or the rate that is neither speeding up or slowing down the economy. As you can see in the chart above, the fed-funds rate is approaching that level. Which is why when Fed Chairman Powell stated in an interview in early October that the fed-funds rate was “a long way from neutral,” markets reacted very negatively. His statement implied that there were many more interest rate hikes on the horizon, which would almost certainly act as a headwind for economic growth. However, just last week, Chairman Powell backtracked on his previous statement, stating that interest rates were “just below” the level that would be neutral for the economy. This led to a sharp drop in expectations for further rate increases. These mixed signals from the Fed are one of the reasons that volatility in financial markets has been so elevated recently. We will find out more at the Federal Reserve’s next meeting later this month, but for now it seems like the Fed has made a slight pivot away from significantly higher interest rates.