Financial encyclopedia

Federal Reserve Chairman Powell said recently: There is no hurry to cut interest rates! Although inflation has dropped, it is still higher than 2%. He also mentioned a key word that the market pays less attention to-"Neutral Rate". This is more important than simply raising or lowering interest rates!

What is a neutral interest rate?

Neutral interest rate will not stimulate or suppress the equilibrium interest rate of the economy, and ensure the stable economic growth.

Interest rate is too low → capital is flooding, economy is overheating and inflation is rising.
Interest rate is too high → enterprise investment is reduced, the job market is under pressure and the economy is slowing down.

Policy interest rate = neutral interest rate → stable economic growth
Policy interest rate < neutral interest rate → monetary policy is still loose.
Policy interest rate > neutral interest rate → monetary policy is tight and the economy may be under pressure.

Key point: the neutral interest rate cannot be directly observed, and it needs to be calculated through data, so it is both important and mysterious!

Why doesn't the Fed directly cut interest rates?

Avoid economic ups and downs and maintain stability.
Excessive interest rate cuts may lead to bubbles and inflation rebound; Raising interest rates too quickly depresses the economy, and the Fed wants to maintain a balance.

Manage market expectations and reduce violent fluctuations.
A sharp interest rate cut may make the market overly optimistic and the stock market crazy; Raising interest rates may cause panic. Neutral interest rate makes market forecast more rational.

Maintain policy flexibility and leave a way out for the future.
If the interest rate is cut too quickly now, once the economy encounters greater challenges, the Fed may not have enough room to deal with it. Therefore, maintain a level close to neutrality and ensure policy flexibility.

How does this affect the market?

The neutral interest rate rises → the interest rate reduction space narrows, and the stock market and bond market are under pressure.
The dollar may remain strong → affect the capital flow in emerging markets.
Interest rate sensitive assets need to be reassessed → Real estate, technology stocks, gold, etc. are affected.

Simply put, the simple logic of "interest rate reduction = stock market surge" is no longer applicable! Investors should pay attention to how the Fed judges the neutral interest rate in order to grasp the market trend!

How should investors respond?

Pay attention to Fed meetings and data (especially inflation and employment)
Flexible adjustment of investment portfolio to cope with market fluctuations
Pay attention to the trend of US dollar and US bond yields and master the flow of funds.
Pay attention to "Dot Plot" and gain insight into market expectations.