The Fed: Higher R* Cometh

Don't be fooled by the Fed's very obvious gaslighting of financial markets designed to manage the rate of ascent in bond yields. R* is going higher.

Discussion

In part 1 of his Jackson Hole preview, Nick Timiraos of the WSJ made it very clear that the Fed’s estimate of the long-term neutral Fed Funds Rate (FFR) - R* as it’s affectionately known - is set to rise. I went through the piece in detail via Xwitter, so I won’t repeat it all here, but the money passage was this:

Every quarter, Fed officials project where rates will settle over the longer run, which is in effect their estimate of neutral. The median estimate declined from 4.25% in 2012 to 2.5% in 2019. After subtracting inflation of 2%, that yielded a real neutral rate (sometimes called “r*” or “r-star”) of 0.5%. In June, the median was still 0.5%.

That also happens to track a widely followed model co-developed by New York Fed President John Williams that also puts neutral at 0.5%. 

But while the median hasn’t changed, some officials’ estimates have been creeping up. In June, seven of 17 officials’ estimates were above 0.5% and only three were lower. A year earlier, eight were below 0.5% and two were above.

This is signaling to the market that R* is going higher. But to those paying attention, this is hardly news.