Is monetary policy in the US (or in any other major, advanced economy for that matter) too restrictive?

Somebody, somewhere, asks that question every, single day. “Somebody” includes policymakers and “somewhere” includes the Eccles building in Washington and sundry outposts around the country.

What’s interesting about this cycle is the (simultaneous) ubiquity of the opposite question: Is monetary policy too loose? That too is a question debated by policymakers in addition to economists and macro watchers.

The latter query might seem, to some, ridiculous — a non sequitur even. But it’s not. It’s an entirely reasonable question to ask because… well, because look at the US economy. Albert Edwards’s protestations notwithstanding, it’s doing pretty well. “Kinda booming,” as Jamie Dimon put it this week.

What accounts for that resilience given Fed funds at multi-decade highs? The simple answer is the very low share of variable-rate debt on household balance sheets, and the corporate world parallel: Very low interest payments as a share of profits.

The chart above tells the story. Or it tells a story, anyway. And you arguably don’t need another one.

If you’re unconvinced that the inoculation illustrated above accounts for the entirety of the US economy’s steadfast refusal to bend, let alone break, the other explanation says the neutral rate’s higher.

The r-star discussion isn’t generally the stuff pageturners are made of, so I was pleasantly surprised at the email feedback I received last weekend when I decided to dedicate the latest Weekly to the neutral rate.

If you haven’t read “Written In The Star,” you should, but the (very) short version goes like this. There’s a very real possibility that neutral’s as much as 200bps higher than the long run dot (which might anyway shift up). If your neutral rate estimate’s too low, you’d be inclined to think policy’s more restrictive than it actually is, which’ll lead you to forecast a recession that never comes.

Why might the neutral rate be higher? Well, one reason is hyper-active fiscal policy, arguably a political and existential imperative in our post-pandemic, war-era macro reality. Socioeconomic shifts tied to COVID, the energy transition, new geostrategic concerns and demands on fiscal policy from both sides of the US political spectrum, all point to wider deficits, hotter nominal growth and, ultimately, a higher equilibrium rate.

Given that, and given his focus on the extent to which fiscal policy explains economic outperformance in the US, it’s notable that Morgan Stanley’s Mike Wilson continues to suggest, citing the FF2s spread, that policy’s too tight.

Twos are policy-sensitive, so they’re just reflecting expectations of near- to medium-term easing. The Fed, despite telegraphing that easing, is clinging to terminal, creating the inversion. But if neutral’s higher and the longer stay at terminal in part reflects a suspicion to that effect within the Committee, then the signal from the inversion may be false, or at least misleading.

To be sure, Wilson’s aware of the tension — or maybe “interplay” is better. “As a result of the better-than-expected economic data assisted in part by fiscal stimulus, the Fed remains on hold in an effort to avoid re-stoking inflation [but] rates remain quite high for many businesses and consumers, particularly those with leverage,” he wrote.

He pointed to surging borrowing costs for some households, businesses and sectors. The charts below illustrate the point for various kinds of personal loans and revolving credit.

As is the case in the corporate world, it’s leveraged borrowers dependent on shorter-term, floating-rate debt, who’re imperiled.

Recall that interest paid on non-mortgage debt eclipsed that on housing-related debt in January. That’s a household-side analogue to various manifestations of the IG-junk juxtaposition on the corporate side.

“Fed funds is well above both the 10-year and 2-year Treasury yields,” Wilson went on. “This inversion is a signal from the bond market that the Fed may be too tight.” He continued: “Borrowing costs are very high for many companies and consumers, which is why rate-sensitive areas of the market/economy have faced headwinds.”

It’s possible that different parts of the economy have a different neutral rate. Indeed, it’s now pretty well understood that there are at least two equilibrium rates: One for the broader economy and one for financial markets. 2022’s UK bond crisis as well as 2023’s US regional bank drama suggest policy settings were unduly tight vis-à-vis the financial stability equilibrium rate, dubbed r-double-star, if not “regular” r-star.

Relatedly, we accept the premise that r-star varies over horizons: There’s short-term r-star and long run neutral. Maybe those stars are aligned at any given time, maybe they aren’t. They almost surely aren’t right now.

So, why not a different neutral rate for every sector of the economy and every income bucket? As I put it in the above-mentioned Weekly, “to the extent it exists, neutral’s at least a little bit different for every state, city, town and hamlet. Something’s always going to be out of balance somewhere.”