Where is the endpoint of this round of interest rate cuts by the Federal Reserve? Goldman Sachs: Around 3.25-3.5%, which is 100 basis points higher than the peak of the previous cycle

When will the Federal Reserve's current rate-cutting cycle come to an end? Goldman Sachs provides the answer: The final interest rate level of this rate-cutting cycle will exceed the traditional neutral rate range and may fall between 3.25% and 3.5%.

This figure means that even after a round of rate cuts, the interest rate level will still be 100 basis points higher than the peak of the previous cycle.

The neutral rate refers to the federal funds rate level that can keep the economy stable under full employment and 2% inflation. At the end of 2019, this estimate was 2.5%, and it has risen to 2.9% in the latest economic forecast summary.

Goldman Sachs pointed out that there are two main reasons for the upward adjustment of the neutral rate, including rising interest rates in the bond market and updated estimates of the neutral rate from economic models. Additionally, the adjustment is supported by current strong fiscal spending and risk appetite, among other non-monetary policy factors.

Federal Reserve Neutral Rate Adjustment: Dual Evidence from Bond Market and Models

The Federal Reserve's valuation of the long-term nominal neutral rate has been raised from 2.5% in 2019 to 2.9%. Goldman Sachs expects that as market factors and model data change, this valuation may continue to rise in the future.

First, the continuous rise in bond market interest rates supports the judgment of an increase in the Federal Reserve's neutral rate. Goldman Sachs noted that Federal Reserve policymakers may refer to the forward rates in the bond market. The current forward rate in the bond market is about 4%, significantly higher than pre-2020 levels, indicating that the market generally believes future rates will remain in a higher range.

Additionally, Goldman Sachs believes that some FOMC members may refer to econometric estimates based on models, which also show an increase in the neutral rate. The Tealbook briefing materials prepared by Federal Reserve staff for the FOMC indicate that the nominal neutral rate estimated by several previously summarized models ranges from 2.8% to 4.6% in the third quarter of 2024, with an average of 3.8%.

The report pointed out that the updated results of the models show that the neutral rate estimate in 2018 was 3.6%, which is 0.5 percentage points higher than the real-time estimate. Although the neutral rate has not risen significantly as some commentators have suggested, the conclusions of these models indicate that the previous estimates were actually too low.

Non-Monetary Factors Affecting the Neutral Rate, Federal Reserve Rate Peak May Reach 3.5%

In addition to the reasons mentioned above, Goldman Sachs pointed out that there are also non-monetary factors at play. Due to large fiscal deficits and strong risk sentiment, overall market demand has been boosted, offsetting the impact of higher interest rates on the economy. This may lead Federal Reserve officials to believe that the final interest rate of this cycle should be slightly higher than the long-term neutral rate.

Data shows that the current U.S. fiscal deficit as a percentage of GDP is about 5% higher than during previous periods of low unemployment. Additionally, the current financial environment remains relatively loose, with strong market risk appetite offsetting some of the tightening policy effects.

Therefore, Goldman Sachs analysts believe that due to these factors, the final interest rate level in this rate-cutting cycle will exceed the traditional neutral rate range, possibly falling between 3.25% and 3.5%. Compared to the peak of the previous rate-cutting cycle, this level will be about 100 basis points higher.**