Did Bullard undershoot? Stifel economists say the Fed Funds rate may need to move to 8%-9%

A day after a Federal Reserve official admitted to the market that interest rates may need to rise by as much as 7%, analysts came to an even more surprising conclusion: that 7% still won’t be high enough to win the market battle . inflation.

In a presentation Thursday in Louisville, Ky., St. Louis Fed President James Bullard estimated that a 5% to 7% fed-funds rate target is needed to move borrowing costs into a zone sufficient to support economic growth. to slow down and a significant drop in inflation. In the wake of those estimates on Thursday, US stocks suffered their first back-to-back losses in two weeks, the ICE US Dollar Index DXY,
+0.26%,
Treasury yields spiked and worrying signals about the economic outlook flashed on many parts of the government bond curve.

However, investors took Bullard’s opinion with a grain of salt. The bond market stabilized early Friday, along with the dollar, until comments from a second Fed official, Susan Collins, triggered an afternoon sell-off of the national debt. Meanwhile, optimism returned to equities, with all three major indexes DJIA,
+0.59%

SPX,
+0.48%
finish 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 thought. One of the most underappreciated risks in financial markets is that inflation will not fall back to 2% fast enough to alleviate the need for more aggressive action from the Fed, traders, money managers and economists told MarketWatch.

Read: Financial Markets Ran Again With ‘Peak Inflation’ Story. This is why it’s complicated.

Economists Lindsey Piegza and Lauren Henderson of Stifel, Nicolaus & Co. said they think even a 7% Fed Funds rate is an “underestimation” of how high the Fed’s benchmark rate is likely to go. Calculations show that there may be a need for “a federal funds rate potentially 100-200 basis points higher than [Bullard’s] suggested upper limit,” they wrote in a note. In other words, a fed-funds rate that is between 8% and 9%, versus the current range of 3.75% and 4%.

“The recent improvement in inflationary pressures transitioning from peak levels has seemingly in some ways blinded many investors to the need for the Fed to press ahead aggressively on the path to higher rates,” they said. “While an annual gain of 7.7% in CPI [or consumer price index] is an improvement from the previously reported annual rate of 8.2% it’s hardly something to celebrate or a clear signal for the Fed to move to simpler policy with a 2% target range still a long way off performance.

Stifel’s economists also said Bullard relies on historically low neutral interest rates, or a theoretical level at which the Fed’s policies neither stimulate nor constrain economic growth, as part of its assumptions.

Piegza and Henderson are not alone. In an unsigned note, UniCredit researchers said that while “7% was nothing short of shocking” for financial market players to hear, the idea of ​​a fed-funds rate ultimately being much higher than most people expect,” not particularly new”.

As of Friday, fed-fund traders typically expect the Fed’s main policy rate target to be between 4.75% and 5%, or between 5% and 5.25%, in the first half of next year. However, standard interpretations of the so-called Taylor rule estimate suggest that the fed-funds rate should be around 10%, the UniCredit researchers said. The Taylor 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 of Bullard, a voting member of the Federal Open Market Committee this year, noting that the policymaker has omitted the impact of the Fed’s quantitative tightening process from his rate estimates.

Once the QT process is factored in, the “inner range” of possible outcomes for the Fed funds rate is “probably closer to” 4.5%-4.75% to 6.5%-6.75%, said Mizuho Securities economists Alex Pelle and Steven Ricchiuto. However, the “full range” of plausible outcomes is even wider, and could be anywhere from 3.25% to 3.5% “on the ultra-dovish side, in which case the Fed is already overtightening”, and 8 .25% -8.5% “on the ultra-aggressive side, in which case the Fed is only half done.”

Chris Low, chief economist at FHN Financial in New York, called Bullard’s presentation “terrific” because “it’s the most honest attempt to shift public expectations for terminal-fed funds into a reasonable range that any FOMC participant has yet seen.” has offered.”

“Keep in mind he went out of his way not to shock the market,” Low said of Bullard. “His zone ranges from gentle to fair, not gentle to aggressive. Our expectations are still being managed. We can’t blame him for that.”

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