I don’t love the narrative that says Fed policy is unduly loose based on the real funds rate. There are too many other (better) ways to make the same point.

You really need to incorporate some forward-looking measure of inflation if you want to assess the extent to which policy rates are restrictive. Unless all you’re trying to do is wave a chart around in the service of galvanizing anti-Fed sentiment.

The real funds rate looked laughably easy for months, ostensibly arguing against a step-down to smaller rate-hike increments (or, more recently, against a pause), but critics tended to leave out the fact that it was tightening from both directions once inflation peaked. If the Fed had continued to raise rates by 75bps (or, more realistically, 50bps) with inflation falling at the same time, the tightening impulse would’ve been amplified well beyond the size of the hikes. At some point, you’d wake up and discover that your policy settings went from incrementally restrictive to draconian virtually overnight in the event inflation suddenly moderated more than expected.

Admittedly, headline CPI is a somewhat misleading way to illustrate this dynamic (it’s better to use PCE or core PCE). But the figure below does underscore why you have to exercise some measure of caution when you’re raising rates rapidly in an environment where the macro outlook is almost completely ambiguous and some disinflation is guaranteed due to base effects and the lagged impact of pipeline deflation in some categories (and moderating price pressures in others).

Adjusted for headline CPI (which, by the way, is the inflation metric Main Street cares about, because it includes energy and food), the real funds rate is screaming higher. Granted, it’s just now back to levels that might be considered prudent for an economy that’s outperforming, but there’s at least one more rate hike coming, and even if the headline prints look less favorable in the back half of the year, growth is probably going to slow.

That, I think, should be considered when we ponder the relative wisdom of less aggressive pricing for rates this year and, perhaps more to the point, the market’s expectation for additional easing in 2024 in the wake of last week’s CPI and PPI figures.

Goldman had some interesting color on this. “Weaker-than-consensus CPI and PPI reports have fueled market optimism on both inflation normalization and Fed policy easing down the road,” the bank’s Praveen Korapaty and George Cole wrote, calling a drop in real rates beyond next summer “puzzling.”

“The price action suggests that, post-data, investors believe more easing is appropriate in H2 2024 and beyond, even if their views on the level of inflation at those horizons remain mostly unchanged, perhaps as a result of ‘excessively restrictive’ policy putting further downward pressure on inflation in the future,” they said.

This is where the proverbial rubber meets the road. The market still seems to doubt the idea that the US economy can handle “higher for longer,” despite copious evidence in support of that notion.

“The economy appears to be resilient to both financial conditions tightening and credit tightening,” Korapaty went on, noting that financial conditions peaked in October.

Recall that Goldman’s US FCI gauge eased sharply last week as the dollar fell with US yields and stocks rallied.

Korapaty also suggested, as did some (read: more than a few) economists last week, that “a significant part of cooling inflation is the result of fading pandemic-era distortions rather than Fed-driven.”

If you ask Goldman, any additional easing that gets priced into 2024 beyond what’s in the market (say, in the event price pressures cool even further) should be faded. BofA’s Michael Hartnett echoed that: The 150bps of easing priced for 2024 is “way too much without a hard landing,” he remarked.

And that’s the crux of the matter. It brings us full circle. The pace of tightening illustrated in the first chart above suggests elevated hard landing risk, regardless of (and in some sense because of) the starting point for real rates. But there’s scant evidence of a looming hard landing. Indeed, it’s difficult to find evidence of any landing during some weeks.