Even After a Rate Hike, the Fed Will Probably Keep Rates Unusually Low for Years

Bond dealers expect the Fed to continue boosting inflation

Federal Reserve: The Search for Consensus on Rates

The Federal Reserve is widely expected to raise interest rates next month, a move that some worry would make it harder for the central bank to achieve its goal of 2 percent inflation.

Wall Street says worry not: A newly released survey of the nation's biggest bond dealers suggests Fed policy will be easy for years, even after a series of rate hikes.

The results show that primary dealers believe the neutral rate—the borrowing cost, adjusted for inflation, that keeps the economy at full employment with stable prices—is currently around zero, and will rise more or less in a straight line to 1.5 percent by the end of 2018. Compare that with the Fed's own projections of where interest rates will be (adjusted for projected inflation) over the next few years. The forecasted path of interest rates (shown in turquoise) will still be lower than the neutral rate (the most recent estimate is shown in navy) through 2018. 

Central bankers use the neutral rate to guide their actions when setting interest rates. If they set their actual benchmark overnight fed funds rate below that neutral rate, policy will be relatively easy and help spur inflation. If they set their rate above neutral, policy will be restrictive and could slow growth and dampen price pressures. The chart above illustrates that dealers expect the former scenario to play out: They anticipate that the Fed will continue providing a boost to economic growth and inflation for years. 

Ever since a speech Federal Reserve Chair Janet Yellen gave in March discussing the concept and its implications for policy, the New York Fed's trading desk has been surveying the 22 primary dealers it transacts with on Wall Street about their views on where the neutral rate is now, and how it will evolve over time. The survey released Thursday was conducted ahead of the FOMC's Oct. 27-28 meeting. 

To be sure, estimates of the neutral rate typically come with wide margins of error. So while dealers' best guess at the moment is that the Fed is keeping interest rates around one percentage point below the neutral level, no one will know for sure until the central bank actually pulls the trigger and begins lifting short-term interest rates from where they have remained near zero for the last seven years.

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