How High Will The Fed Go?

The Fed raised rates by 50 bps this week. The market is thinking that the Fed will raise rates to ~3% and then stop. However, based on historical actions that seems pretty unlikely.

This is a graph of Fed Funds vs. CPI since 2000. Look carefully at what happens when the Fed starts raising rates.

The last two rate hike cycles the Fed hasn’t stopped raising rates until Fed Funds was higher than CPI. i.e. Real Fed Funds was positive.

As you can see, the Fed needs to go a LOT higher than 3% to make the Fed Funds rate have a positive real yield. Yes inflation is likely to moderate some, but it would have to fall under 3% to make 3% Fed Funds cause the same relation.

Bottom line: There is some risk the Fed is going to have to go farther than the market expects which has a lot of risks for asset prices and the overall economy.