The Joy of Neutrality?
There is a widespread belief that the U.S. Federal Reserve remains on track to boost interest rates back towards more "neutral" levels. The only question is: what is neutral?
To figure that out, it makes sense to look at what has been the norm over several decades. Not only for nominal interest rates, but for inflation-adjusted -- or "real" -- interest rates, too.
As it happens, the median monthly nominal and real effective federal funds rate during the past 50 years has been 5.31% and 1.76%, respectively, while comparable yields on 10-year Treasury bonds have been 6.31% and 2.65%. The monthly year-on-year gain in consumer prices has averaged out to 3.30%.
Under the circumstances, one could argue that with February's 4.49% fed funds rate lying 82 basis points beneath the median -- and the 0.89% inflation-adjusted rate 87 basis points shy of its average -- we should be looking for at least three more 25-basis point hikes.
Moreover, with February's 4.57% 10-year Treasury yield 174 basis points below normal -- and the real rate of 0.97% a similarly wide 168 shy of its 50-year median -- we should expect to see much higher bond yields -- and sharply lower prices -- than we have now.
Not to mention the fact that if reported inflation turns out to be understated -- as many now believe -- the rate rises to come are likely to be far more dramatic.
Whatever the case, it seems wrong to assume that the 25-basis point rate hike set to occur at next Tuesday's FOMC meeting will be the last -- as bullish proponents of the so-called "one-and-done" perspective have been arguing.
Or that the sell-off in bonds, which has boosted longer-term yields by around 40 basis points over the past two months, will be ending any time soon.
So much for the joy of neutrality?