Former Federal Reserve vice chair Richard Clarida shared his opinion about what would happen to interest rates now that the Fed has cut rates after four years. Clarida explained on FT that the level at which interest rates settle will be crucial to the entire economy, mentioning that it was not only a matter of semantics.
According to Clarida, economists usually discuss the neutral policy rate, also known as the R-star, ‘narrowly.’ Clarida explained that while the neutral policy rate is usually important to the economy, it has little effect on economic growth. The former Fed vice chair referred to the policy rate as the interest rate Goldilocks zone.
Clarida speculated that the R-star rate would modestly increase from the pre-pandemic 0.5%. The former Fed vice chair insisted that R-star estimates are not usually exact despite the rate being crucial to understanding how monetary policies might change.
However, Richard noted that other economists thought the neutral rate would need to increase more than the projected 1%. The former Fed vice chair explained that the economists gave several reasons behind their belief that the neutral rate would be higher than in the pre-pandemic years.
One factor economists were looking at was conditions before the pandemic that kept interest rates low. Another possible factor that could trigger a higher neutral rate was the increasing debts and deficits that could harm the U.S. economy. The third reason Clarida cited was the possible AI productivity boom that could increase loan demands from the U.S.
Richard expects a shift to pre-pandemic times
The former Fed Reserve vice chair noted that the current U.S. economic situation would adjust to how the state was before the pandemic. Richard explained the positive U.S. yield curve slope experienced before the global financial crisis. The ex-Fed vice chair assured that the current inversion seen in the country’s yield curve is not the ‘new normal.’
Richard also confirmed that the adjustment will increase the demand for U.S. fixed income and balance it. The ex-Fed vice chair explained increased rates to compensate investors for holding on to debts longer. Clarida referred to the compensation as a term premium, which would encourage the demand for fixed income. As such, bond investors earn a higher term premium to soak up the debt offering coming into the markets.
The former Fed Reserve chair still mentioned that the rates to compensate investors would be higher than in years before the pandemic. However, Clarida expects that the rewards to fixed-income investors for holding bonds through good and bad economic times will be worthwhile.
Mortgage rates are on the rise despite Fed efforts
The US housing market was looking shaky even before the recent rise in mortgage rates. Mortgage applications for home purchases have been stagnant while the number of homes under construction has been falling. According to the Atlanta Fed's GDPNow model, real residential… pic.twitter.com/kQJWpwUbB7
— Peter Berezin (@PeterBerezinBCA) October 10, 2024
Many economists expect interest rates to stabilize and improve as inflation slows down and the labor market is fully employed. However, mortgage rates have been rising since the Fed interest rate cuts.
According to Freddie Mac, the 30-year fixed-rate mortgage average increased by 0.2% on October 10, reaching 6.32%. The company revealed that despite the increase, the inflation rate will remain down this month.
Freddie Mac’s chief economist said that the increased 30-year fixed rate mortgage has seen the largest one-week increase since April. Freddie Mac data revealed that the 6.32% average was lower than one year ago, marking a 1.25% decrease despite the increase.
The company’s chief economist Sam Khater insisted that the one-week increase was not due to the economy but rather a shift in expectations. Khater also explained that increased rates show economic strength to fuel the housing market recovery.
