"....Treading trodden trails for a long long time, I find sometimes its easy to be myself, sometimes I find its better to be somebody else." Dave Matthews
The SP is retreating and pundits are quick to reflect the price action back at the Fed and its discussion of adjusting the funding rate. The truth is the Board has done everything it can to soothe the anxious about flicking away from ZIRP. The calibration of monetary policy is always more important than the level of rates.
In a Rates Targeting Regime ( a place we are not now) a CB can find itself "too tight" at 3% - see Aug 2001- or "too loose" at 5% - see Nov 2005. In a Quantitative Regime, or more specifically, in the transitional phase of a Q-Regime, very little can be extrapolated from the base rate as to the calibration of policy. By definition, ZIRP is zip. We have expressed our view several times before that LSAP was a necessary monetary accommodation given the "equilibrium" funding rate of zero. To a CB, the equilibrium funding rate is the rate at which you are Neutral, neither accommodating nor restricting the liquidity functioning of the financial system.
A few months back, we showed that the "rate", if set by the market instead of the CB was beginning to rise. Today that estimated neutral rate is a Shylock-ian 23 basis points ! (according to our model,,yada yada, been there ) Now the tricky part, the Hillary Step (not that Hillary #GIK) of regime change. At the present market construct the CB and FF would calibrate themselves to mildly snugging IF a change resulted in a 25 to 50 window and a lobotomized market price of 37bp.
Either the range would have to establish from 12 to 37 (and mkt price of 25/24) OR market rates need to adjust higher still to keep the CB at neutral. We believe the adjusting neutral stance is still warranted and appropriate given domestic and global economic pictures. (We recognize this view is not shared by many/all). The point we are clarifying is marginally HIGHER than prevailing structures are needed to keep the CB from snugging up too quickly, a counter-intuitive conclusion.
As we joked yesterday in the "Finance Twitter" (i just love that oxymoron) stream : The Fed and the term structure of short money rates have a unique reactive relationship. We/they represent a Hawthorne Effect (#GIK) of being both the observer and the observed. One last reminder, transversing the chasm from QE back to a Rates targeted regime has not been successfully done. At the Hillary Step of Everest, you die alittle with every movement forward, you make it or fail miserably. Anyone know any good Sherpas ??