Source: Wall Street See

When will the Federal Reserve conclude this round of interest rate cuts? Goldman Sachs provides the answer: the ultimate interest rate level of this round of interest rate cuts will exceed the traditional neutral interest rate range, likely falling between 3.25% and 3.5%.

This figure means that even after a round of rate cuts, the interest rate level will still be 100 basis points higher than the peak of the previous cycle.

The neutral interest rate refers to the federal funds rate that can keep the economy stable under full employment and 2% inflation. At the end of 2019, this estimated value was 2.5%, and it has risen to 2.9% in the latest economic projections summary.

Goldman Sachs pointed out that there are two main reasons for the upward adjustment of the neutral interest rate, including rising interest rates in the bond market and updates to economic models predicting the neutral interest rate. Additionally, the adjustment is supported by current strong fiscal spending and non-monetary policy factors such as risk appetite.

Federal Reserve neutral interest rate adjustment: dual support from the bond market and models.

The Federal Reserve's valuation of the long-term nominal neutral interest rate has been raised from 2.5% in 2019 to 2.9%. Goldman Sachs expects that as market factors and model data change, this valuation may continue to rise in the future.

Firstly, the interest rates in the bonds market have continued to rise, supporting the determination that the neutral interest rate of the Federal Reserve is increasing. Goldman Sachs points out that the policymakers of the Federal Reserve might refer to the forward rates in the bonds market. The current forward rate in the bonds market is about 4%, significantly higher than the levels before 2020, indicating that the market generally believes that future interest rates will remain at a high range.

In addition, Goldman Sachs believes that some FOMC members may refer to model-based econometric estimates, which also show an increase in the neutral interest rate. The Tealbook briefing materials prepared for the FOMC by the Federal Reserve staff indicate that the nominal neutral interest rate estimated by several previously summarized models ranges from 2.8% to 4.6% in the third quarter of 2024, with an average of 3.8%.

The report points out that the updated results of the models show that the neutral interest rate estimated in 2018 was 3.6%, which is 0.5 percentage points higher than the real-time estimate. Although the neutral interest rate has not increased as significantly as some commentators claim, the conclusions drawn from these models indicate that previous estimates were actually too low.

Non-mmf factors affect the neutral interest rate, and the peak interest rate of the Federal Reserve may reach 3.5%.

In addition to the above reasons, Goldman Sachs points out that there are also non-mmf factors providing support. Due to large fiscal deficits and strong risk sentiment, total market demand has been boosted, which offsets the impact of higher interest rates on the economy. This may lead Federal Reserve officials to believe that the final interest rate in this cycle should be slightly higher than the long-term neutral interest rate.

Data shows that the current ratio of the USA fiscal deficit to GDP is about 5% higher than during previous periods of low unemployment. In addition, the current financial environment remains relatively loose, and market risk appetite is strong, which offsets some of the tightening policy effects.

Therefore, Goldman Sachs analysts believe that due to these factors, the final interest rate level of the Federal Reserve in this round of rate-cutting cycle will exceed the traditional neutral interest rate range, likely between 3.25% and 3.5%. This level will be approximately 100 basis points higher than the peak of the previous rate-cutting cycle.

Editor / jayden