Fed lifts neutral view; more to come?: McGeever

investing.com:

By Jamie McGeever

ORLANDO, Florida (Reuters) -Fed policymakers on Wednesday kept their 2024 U.S. interest rate projection unchanged, but the floor for rates once cuts start is moving higher.

In their quarterly Summary of Economic Projections, officials raised the median outlook for 2025 and 2026, and more importantly, increased their longer-run median interest rate outlook above 2.5% for the first time in five years.

The median 2025 and 2026 rate views were raised by three tenths of one percent to 2.9% and 3.1%, respectively, and the longer-run rate was lifted by one tenth of a percentage point to 2.6%.

As the Fed maintained its long-run inflation projection at its 2% target, this implies a slight increase in what policymakers deem to be the neutral real rate of interest, or 'R-star', to 0.6% from 0.5%.

These were small changes, particularly to the longer run projection, but they could be significant.

Collectively, they show the Fed recognizes that policy needs to be tighter for longer in the post-pandemic world to get inflation back down to target and keep it there. Seven Fed officials now see a neutral rate of 2.9% or higher, compared with four in December.

Another way of looking at it, with growth consistently surprising on the upside, the post-pandemic U.S. economy is much less responsive to interest rate hikes than it was before March 2020.

These are hardly new revelations — rates futures markets have for some time priced in a higher terminal rate than that implied in the SEP projections — but the highest neutral rate outlook since 2018 is a marker.

The question now is whether that gap between the market-based and Fed view for the terminal rate, the policy rate once the easing cycle ends, begins to converge.

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