2022-09-09

Forward Real Rate Says Powell Could Be the Ultra Volcker

What is the real interest rate moving forward? This chart shows the Fed funds rate minus the CPI, a hindsight look at real rates.
The CPI for Q3 will annualize to about 1 percent if prices don't continue dropping. I suspect they might and that CPI might be near 0 percent by October as a result. The Federal Reserve should hike to 3.50 percent in September and signal 4.00 percent for November. Looking forward, the real interest rate could be positive 4 percent or higher by the end of the year. 

Now go back to Q2 when inflation was running at 10 percent annualized in the quarter and the Fed funds rate was averaging about 0.50 percent. If you accept the above assumptions are reasonable, then it's quite possible the real rate of interest (defined by Fed funds minus CPI) will have swung from about negative 10 percent to positive 4 percent. Volcker took rates from minus 4 percent to positive 10 percent. The CPI also rose straight through this period. There wasn't a peak and reversal in prices as is happening now, technically Powell's swing in real rates won't seem as impressive as Volcker's looking at the 12-month CPI, but the reversal in real rates from Q2 to Q4 will be even more dramatic when one considers the economy could see a double-digit down swing down in the CPI. Impressive.

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