Fed Funds and Natural Rate of Interest

The Fed’s decision to raise is found from the 10 to 12 year Fed Funds monthly averages. Those averages are located at the 10 year at 0.69 to the 12 year at 1.32. Next above the 12 year is the 15 year average at 1.34. Range then is 0.69 to 1.32. Current Fed funds trades at 0.66 and closed at 0.66 everyday since December 2015.
Fed Funds monthly averages from 1 to 9 years range from 0.16 to 0.41 while Medians, always lower than averages, range from 0.12 to 0.39. Every average from 1 to 9 years is severely and in Richter Scale overbought territory. From Medians, overbought surpasses Richter Scale points to reach upper stratosphere proportions.
When Fed Funds long term averages was last visited in August 2016, the range of averages from 1 to 9 year was then 0.14 to 0.55. In 7 months, the low end rose 2 basis points while the topside dropped 14. Medians today are 0.12 to 0.39 while August 2016 saw Medians from 0.11 to 0.39. Medians failed to move in 7 months.
The 5 year average in August was 0.14 and rose to today’s 0.18 by 4 basis points. The 10 year average was 1.02 in August and now dropped 33 basis points to current 0.69. Averages then were in far far overbought zones. Today’s overbought points are far higher than in August. The average driving Fed Funds is the 9 year average and the same average from August 2016.
Targets in averages from 1 to 9 years, to demonstrate what overbought means, ranges from 0.26 to the 9 year at 0.71. Subtract the 9 year highs then targets range from 0.26 to 0.49. Current Fed Funds at 0.66 is easily 20 basis points to high. Current Fed Funds in August was 20 basis points to high.
Averages from 12 to 25.4 years range from 1.32 and 1.34 to highs at the 25 year at 2.67. Averages from 12 to 25 years is not oversold but rather averages are trending lower. Above the 12 and 15 year at 1.32 and 1.34 then the next average is the 17 year at 1.70 and 20 year at 2.24. A wide area exists from 1.34 to 1.70 then 2.24. The longer averages are dropping.
The 20 year average for example in August was 2.44 and today 2.24. The 17 year average in August was 1.94 and today 1.70.
The Natural Rate of Interest in August from the 20 year average was 1.64 and today it dropped to 1.04. The 17 year average in August was 1.14 and today 0.50. The 15 year average in August was 0.64 and today 0.14. The 10 year average in August was 0.22 and rose to 0.55. The 5 year in August was 0.66 and today 1.02.
The Natural Rate of Interest informs not only should Fed Funds remain in current position but the economy is ranging from 0.14 lows to 1.02 and 1.04. The Natural Rate in August ranged from 1.64 highs to 0.22 and 0.64 lows. GDP for Q4 2016 was 1.9 and barely above half the distance from 1.64 to 0.64. The Natural Rate 7 months later dropped 70 basis points from 1.64 to 1.04.
The Fed target for Fed Funds down the road is above the Natural Rate of Interest at 1.04 at the 20 year average. Yet factor the 25 year average, the Natural Rate is actually 1.47. The economics aspect to Fed Funds is non supportive to raise.
Current Fed Funds varied from averages in ranges from 0.20 % lows at the 1 year to 0.78 % at the 15 year. Subtract the 20 lows then ranges actual were 0.50% to 0.78%.
The Signal Noise Ratio is more of a factor as current Noise in Fed Funds is high at 0.66 but not yet at an alarming rate. Raise Fed Funds further then the Signal not only would become far elevated but Fed Funds at high Signals won’t perform as expected.
The end result is Fed Funds as in August is far far overbought and in dire need of a 20 basis point correction. Medians are far more overbought than averages. My opinion remains the same as August, don’t raise because it will result in economic problems and a cut later. Raise more than one time then the Signal line goes to unsupportive upper boundaries.
Ask how many times the implied probability calculators used by many failed over X amount of meetings. I see the Fed’s desire to raise by placing Fed Funds above the Natural Rate but Fed Funds is not ready to rise and actually has a long way to go before a raise should be considered.

Brian Twomey

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