The big debate in financial markets over Federal Reserve policy is no longer about when officials will raise interest rates but about how high they will go.
Investors and economists disagree on whether the Fed’s tightening cycle -- expected to begin on Wednesday -- peaks somewhere in the 2 percent range or lower, versus 3 percent or higher. All but three Fed officials, as of September, estimated the benchmark lending rate would be between 3 percent and 4 percent at the end of 2018. Market rates reflect investor skepticism: the 10-year U.S. Treasury note currently yields 2.2 percent.
The debate reflects unresolved questions about the U.S. economy more than six years after the expansion began. Why has worker output per hour slumped and will it come back? Can more working-age Americans be tempted back into the job market? Will U.S. wages accelerate at a faster pace?
“You should see a stronger global economy, you should see more credit creation and stronger housing,” said Neil Dutta, head of U.S. economics at Renaissance Macro Research LLC in New York, who expects the policy rate to peak around 3.25 percent in 2018.
Robert Brusca, the head of Fact & Opinion Economics in New York, called such outlooks a “happily ever after” story that ignores the potential for further gains in the dollar to hurt trade and manufacturing. “I feel more comfortable in the 2 percent camp,” he said.
Liftoff Meeting
Just how the debate resolves has big implications for Americans households and businesses who borrow, as well as investors around the world. The policy-setting Federal Open Market Committee is scheduled to release its decision at 2 p.m. Wednesday in Washington, and investors see a 78 percent probability it will lift rates by a quarter percentage point from near zero.
Fed officials projected their policy rate at 3.4 percent at the end of 2018, according to their median quarterly estimate released in September. Eurodollar futures -- another indicator of where short-term rates are headed -- are currently pricing three-month money at around 2 percent by that time.
“It is very important to get this right, and to know if the central bank is not getting it right,” Brusca said. “It matters to people who buy bonds and it matters to people who invest in stocks.”
Neutral Rates