The terminal rate will be lower than in the past but very likely
The terminal rate will be lower than in the past but very likely
higher than current market expectations
The neutral rate has fallen since the crisis — but the rate implied by
market pricing is consistent with a very pessimistic scenario
Neutral rate estimates
3-3.25%
2.00%
Market pricing DB
Neutral rate estimates are consistent with:
Potential
growth
Productive
-ty growth
Source: C60. Laubach and Williams (2004 POMO. Deutsche Bank Research Fed Pre-crisis*
0.6%
0% 1.75-2%
1.25% 2-2.25%
1.5% 4.50%
3%
2%
No (1 Avg. 1995-2005
Several of the reasons for a lower terminal rate have faded
Fiscal policy
Private
deleveraging
Mortgage cre-
dit conditions
Subdued
global growth
Low potential
growth Reducing Rationale
terminal rate?
•
•
•
O
O
Deutsche Bank Research • Fiscal policy has shifted from a significant
drag to neutral
• Deleveraging slowed significantly: credit
growth picking up
• Still tight but showing some signs of
loosening
• Global growth, giving less external impulse
to US growth
• Still low but should rise modestly as
productivity picks up
Kiattetrihre.,="olt • How high the Fed's policy rate eventually rises (i.e.,
the terminal rate) is closely tied to the neutral rate
- A higher neutral rate means the Fed has to raise
rates more to tighten financial conditions
■ Estimates suggest the neutral rate is currently very
low due to growth headwinds (e.g., fiscal drag, tight
credit, slow global growth), lower potential growth
■ Neutral rate should rise as these headwinds fade
and potential growth improves...
• ...But estimates suggest that the long-run neutral
rate will remain lower than in the past
- Prior to the crisis the neutral rate was near 4.5%
- Fed's estimate is currently 3.25-3.50%; we think
it is somewhat lower (i.e., 3-3.25%)
• The market pricing of a terminal rate around 2% is
consistent with a very pessimistic economic
scenario, assuming no rebound in potential growth
• As the market reprices the pace of hikes, it will also
have to raise its view on the terminal rate
12
Note (e): FOMC committee's leadership (Yellen. Fischer and Dudley) kke1f expect only 3-4 hikes
CONFIDENTIAL - PURSUANT TO FED. R. GRIM. P. 6(e)
CONFIDENTIAL DB-SDNY-0119259
SDNY_GM_00265443
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