Stock markets rallied after Fed Chair Jerome Powell’s speech at the Economic Club, New York. Market players were thrilled amid their interpretation that Powell has turned dovish, probably succumbed to Trump’s endless criticism. We do not see an abrupt turn on Powell’s stance.

What the market focused on was Powell’s reference that “interest rates… remain just below…neutral”. This has led some to expect that Fed’s rate hike path is coming to an end. Those who got so excited after Powell’s speech probably tried to compare the current Fed funds rate with the median dot plot. In September, the staff’s projection of neutral rate ranged from 2.5% to 3.5%, with the median at 3%. Such projection would probably be similar in December. With the current Fed funds rate target range at 2-2.25%, with the mid-point at 2.125%, the Fed might only raise the policy rate by about three times ((3%-2.125%)/0.25% = 3.5 times).

The concept of “neutral interest rate” is often misinterpreted. It is in fact the level of interest rate that would neither speed up nor slow down economic growth. This interest rate is not fixed, as it can be changed over time in accordance with economic development. Indeed, the Fed has always emphasized that it does not know where the neutral rate is. Moreover, there is no such rule that rate hike has to stop after reaching the neutral rate or that the policy rate cannot exceed the neutral rate.

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In September, the median dot plot pointed to a neutral rate of 3%. Yet, the projected rate for 2019 and 2020 were 3.1% and 3.4% respectively. therefore, it is imprudent to assume that the Fed funds rate at an economic cycle should peak at/below the neutral rate. Powell suggested October 3 that the Fed might raise rates past neutral, and there is probably “a long way” from that point. We do not see his latest comment as contradictory from this. Indeed, Powell also affirmed that current interest rates” are still low by historical standards” in his latest speech.

Independence is of utmost importance for a central bank to perform its functions effectively. The government in power certainly hopes to boost growth and reduce unemployment rate without limit. This is the best way for them to gain popular support. If governments/ political parties are allowed to intervene monetary policy, they would likely be incentivised to keep interest rates low for promoting growth. In this case, central bank’s ability to stablise inflation would be compromised.

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