Fed's "Third-in-Command" Paves the Way for Rate Cuts: Low Neutral Rate Era to Persist

On Monday Eastern Time, the Federal Reserve's "third-in-command" and New York Fed President John Williams stated that, based on his interpretation of the data, the era of persistently low neutral interest rates in the United States does not seem to be over.

Williams' remarks came just after Fed Chair Powell first hinted at the possibility of a September rate cut during the Jackson Hole meeting last Friday, opening the door for easing. This highlights the difficult balance Fed policymakers are striking between addressing weak U.S. employment and inflation risks, potentially setting the stage for a subsequent Fed rate-cutting cycle.

Fed's "Third-in-Command" Hints Neutral Rate Has Not Risen

Williams expressed this view during a speech at a conference in Mexico City. In his address, Williams did not directly comment on the near-term monetary policy outlook but discussed a core parameter influencing Fed monetary policy—the "neutral interest rate (R-Star)."

The neutral rate refers to the estimated level of interest that has a neutral impact on the economy, striking a balance where the economy achieves equilibrium with full employment and stable prices. This rate cannot be directly observed and can only be inferred.

Williams stated that the growth-adjusted R-Star index for the U.S., eurozone, U.K., and Canada is approximately 0.5%, similar to pre-pandemic levels.
Will Low Rates Return at Some Point?

Some events in recent years have made estimating R-Star challenging, such as the pandemic-related surge in inflation—which prompted central banks worldwide to sharply raise interest rates.

Lately, some Fed officials have been steadily raising their estimates for long-term interest rate targets, suggesting a fundamental shift in the U.S. economy toward higher borrowing costs.