Will the Real Fed Funds Rate Please Stand Up?
We have written often about the quality and quantity of the macroeconomic research produced by the regional banks that make up the Federal Reserve System, with two of our favorite sources being the St. Louis Fed’s FRED website and the Atlanta Fed’s GDPNow website (which, as of November 9th puts Q4 real GDP at a very healthy 4%). If you haven’t yet investigated either site, we highly recommend doing so. And this week we turn our attention to a third regional bank and a bit of research that – given the market’s focus on inflation and monetary policy – strikes us as particularly timely, and those are the Federal Reserve Bank of San Francisco and its Economic Letter that looks at a “proxy” Federal Funds Rate (you can find the FRBSF Economic Letter on the bank’s economic research page).
In a nutshell, the authors of the Letter compare the stated Fed Funds Rate (which, as we know today sits between 3.75% and 4.0%) and a proxy Fed Funds Rate that considers the impact of the Fed’s forward guidance (which as we know has been quite hawkish of late) and the impact of the Fed’s balance sheet activity (which as we know has been shrinking of late as the Fed has moved from quantitative easing to quantitative tightening, which is also quite hawkish) on monetary policy. According to the Economic Letter, when those two additional factors are considered, the result is a proxy Fed Funds Rate which is meaningfully higher than the stated Fed Funds Rate (at 5.25%+ vs 3.75% to 4.0%, see chart), which makes sense to us, again, given the Fed has more than once stated its determination to bring down the rate of
inflation and the Fed is aggressively shrinking its balance sheet.
If the research is on point, and monetary policy is much tighter than previously thought, we think a few conclusions, positive and negative, can be drawn – on the positive side of the ledger, it is possible that the Fed is much closer to winning its battle against inflation and much closer to the end of its rate hiking cycle than we thought; on the negative side of the ledger, it is possible that the Fed has already gone too far, too fast in tightening monetary policy, and in so doing has made an economic hard landing more likely than we thought.
The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital Investments, LLC, a registered investment advisor. 2191-BCI-11/14/2022