Risks around Fed policy in a soft landing
The Fed hopes it can achieve a soft landing, lowering the policy rate to around 3%, broadly matching its estimate of the neutral rate.
Chair Powell argued yesterday that the Fed's 50bp rate cut represented the FOMC “recalibrating policy down over time to a more neutral level”, where “the neutral rate is probably significantly higher than it was [before COVID]”.
Consistent with the Fed still aiming for a soft economic landing, the updated median FOMC forecasts have the policy rate falling to 2.9% by end-2026 and holding at that level in 2027, matching the median policy-maker long-run neutral estimate of 2.9%.
The FOMC has been nudging the median estimate of neutral higher all this year, with the 2.9% estimate the highest since 2018 and with the median neutral forecast previously steady at about 2.5% from 2019 to 2023.
However, the range of policy-maker estimates around the median forecast of a 2.9% neutral rate is still the widest it has been since the FOMC started publishing its forecasts in 2012.
This is seen in the 1pp range for the “central tendency” of individual policy-maker forecasts of the neutral rate from 2.5% to 3.5%, where the central tendency excludes the three lowest and three highest individual projections.
Looking at the distribution of policy-maker forecasts within this wide central tendency, it wouldn’t be surprising if the FOMC median forecast of neutral keeps edging higher, closing the gap with the roughly 3½% average estimate derived from market pricing and Fed staff models.
However, history shows that the long-term FOMC forecasts are usually wrong and if the US economy ends up in recession, the Fed will likely take the funds rate below the neutral rate into the 2s.
In such a scenario, government policy could limit the ultimate easing in monetary policy, or perhaps shorten the duration of the low in rates.
This is because both sides of politics already plan to spend more money regardless of the state of the economy and the republicans would additionally boost inflation through tariffs, planned large-scale deportations, and pressure on the Fed.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy, contributing to the investment decisions of the firm. Kieran has long experience as a macroeconomist in both the private and public sectors. He has worked most recently as Chief Markets Economist for National Australia Bank and was previously Chief Economist, Australia and New Zealand, for Barclays Bank and ABN Amro Bank/RBS. Kieran also worked as Principal Adviser on the macroeconomy and budget policy in the Commonwealth Treasury and Director of Forecasting.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
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