The Fed just made a move which could mark the end of the cycle.
Yesterday, the Fed released their new Summary of Economic Projections (SEP) which also includes the famous ”Dot Plot”.
Headlines mostly focused on:
– 2024 changes: there is only one (!) cut seen this year as the median outcome by FOMC voters versus three cuts forecast at the March meeting;
– 2025 changes: an additional cut is now in the 2025 forecast, which should bring Fed Fund rates to ~4% by the end of next year
But to me, the most important change in the Dot Plot was in the Long-Run Dot, also known as the neutral nominal rate.
What is that?
The neutral nominal Fed Fund rate is the policy rate at which the US economy can deliver its potential growth and inflation without overheating or excessively cooling.
It’s an unobservable interest rate which can only be estimated, and it would basically serve as the equilibrium rate for the US economy.
The Fed bumped it up by another 20 bps yesterday, bringing it at 2.75%.
Why does it matter?
In 2018 the Fed was hiking rates trying to slow the US economy down, and around September Powell came out saying ”we are still far from neutral rates” and the FOMC moved their long-run dot higher all the way up to 3% (blue line).
Coincidentally, this was exactly the moment that marked the peak in bond yields.
Because of the pro-cyclical and unobservable nature of the long-run dot and the Fed’s herd behavior in joining the pack in calling for ”higher for longer” very late, when the Fed moves this estimate we are generally very late in the cycle.
Today, the story is even more interesting: the Fed is bumping up their Long-Run Dot, but the market is even pricing a more aggressive equilibrium rate at 3.5% (blue) putting pressure on the economy.
If the 2018 history repeats, the Fed just made a move which could mark the end of the cycle.
