The Fed: Kashkari Updates His TIPS 10s View

Discussion

FRB Minnesota President Neel Kashkari’s June 17, 2022 essay detailing how the Fed likely needed to drive TIPS 10s up to 200 bps to bring inflation under control was pivotal in my thinking on the Fed’s tightening cycle, as it gave a very precise level to watch in the bond market. In an appearance last night Kashkari updated his view, saying that yes TIPS 10s are now at 200 - the level of tightening it took in 1994 to bring inflation down - but now the questions are whether the inflation dynamic today is different than in 1994 and/or has the real neutral rate risen since COVID?

In his June 17 essay Kashkari’s key assumption was that the neutral rate of interest on TIPS 10s was 0%. In the context of the hawkish SEP last week and Chair Powell’s comment about only knowing the neutral rate of interest “by its works,” the mere fact that Kashkari is questioning whether the neutral rate has risen means he believes it has.

As shown in the chart below, this morning TIPS 10s are trading at 216 bps. If you think about the neutral rate rising in increments of 25 bps, at minimum the post-COVID neutral rate is 25 bps, implying the Fed wants to see TIPS 10s rise to at least 225. More likely the neutral rate has risen by 50-100, which means the Fed believes it has not reached “sufficiently restrictive” until TIPS 10s rise to between 250 and 300 bps.