Fed Funds and Taylor Rules: January 2017 to October 2017

As John Taylor is considered for a Fed position on the Board, a check on his invention to his 1997 rules as his rules replaced central bank’s preferred and widely employed Monetary Condition Indices.

 

Two methods to view Taylor Rules. The first, 0.5 in the first formula is employed as the Coefficient to hold the balance throughout the full calculations. Current Inflation is also employed rather than the second method to use 1.5 and Inflation Target of 2.0%. Both are valid as a view into not only Fed Funds and levels but the Output Gap measured by GDP minus GDP is at current 0.2 and trades above Inflation at 0.1. The current Out Put Gap at 0.2 is extraordinarily low and matches against January 2017. All 2017, the Out Put Gap hasn’t changed.

 

To use the 90 day rate at 1.07 for the first formula then current Fed Funds should be at 1.18 and its close to the current 1.16 close price over the past months. To use actual 1.16 Fed Funds then the current rate should be located at 1.27. The range overall, 1.18 to 1.27.

 

To use the second method as is the way for the RBNZ at 1.5, the 2.0% target and 90 day interest rate then FED Funds should be targeted at 0.657. What 0.657 represents is support for the 1 month interest rate as it closed today at 1.07. This is Yellen’s Floor for Fed Funds and must rise to see any shot to raise. But the Output Gap must move higher.

 

Here’s what we’re working with in the first method.

Current PCE + 0.5 X ( Inflation minus Inflation) + 0.5 X ( GDP Minus GDP) + Interest Rate. Inflation 1.8 minus Inflation 1.7 = 0.1 while GDP 2.20 minus GDP 2.00 = 0.2. Today’s 90 day close at 1.07 factored offers Fed Funds at 1.18 while actual Fed funds used offers 1.27. For context, the 10 year real yield factors to 0.57 while 10’s minus 2’s equals 0.78. The 10 Year minus 3 month equals 1.20. Doesn’t speak much regarding a raise anytime soon.

 

The second Method Fed Funds target = 90 day + Inflation target + 1.5 X (Inflation minus Inflation) + 0.5 X ( GDP Minus GDP ). Here we have Fed Funds at 0.657 so overall range 0.657 to 1.07 roughly.

 

Comparison October 2017 to January 2017

 

To use the 90 day rate at 0.51 for the first formula then current Fed Funds should be at 0.69 and close to the current 0.66 close price over the past months. To use actual 0.66 Fed Funds then the current rate should be located at 0.84. The range overall, 0.69 to 0.84.

 

To use the second method as is the way for the RBNZ at 1.5, the 2.0% target and 90 day interest rate then FED Funds should be targeted at 0.46.

 

For context in January, the 10 year real yield factors to 0.88 while 10’s minus 2’s equals 1.27. The 10 Year minus 3 month 1.97. Doesn’t speak much regarding a raise anytime soon.

 

The 10 minus 3 month spread dropped 77 basis points from January to October while the 10 to 2 year dropped 49 basis points. The Real yield dropped 31 basis points.

 

The 90 day rate in January was 0.51 and today is 1.07 for a 56 basis point jump. Fed Funds January 2017 was 0.66 and today 1.16 for a 50 basis point rise.

 

The Out Put Gap remains stagnant for 9 consecutive months and the overall concern as every central bank policy remains focus to protect bottoms while not to consider the future economics. The small channel is roughly 50 basis points and this won’t bring economic prosperity.

 

Brian Twomey, Inside the Currency Market, btwomey.com

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