In April of 2021, we published a Weekly Wire carrying the headline When People Stop Being Polite and Start Getting Real, which was both a nod to the 30th-anniversary reboot of the original MTV reality series and a nod to the Real Fed Funds Rate and what it might mean for the economy. As we know, the Real Fed Funds Rate considers the Fed Funds Rate relative to the rate of inflation, with a Fed Funds Rate above the rate of inflation translating into a positive Real Fed Funds Rate (which is more of a headwind for economic growth) and a Fed Funds Rate below the rate of inflation translating into a Negative Real Fed Funds Rate (which is more of a tailwind for economic growth). At the time, the Real Fed Funds Rate was deeply negative (see chart) as the Fed had taken the Fed Funds Rate to zero as we managed through the worst of the pandemic.
A few months back we revisited the idea of the Real Fed Funds Rate in a Weekly Wire that looked at the rate of inflation relative to a “proxy” Fed Funds Rate that considered the impact of quantitative tightening, or the shrinking of the Fed’s balance sheet, on interest rates, and by that metric, the Real Fed Funds Rate had flipped positive. Now, with the Federal Reserve raising the Fed Funds Rate last week by 25bps to a range of 4.50% to 4.75%, and the Fed’s preferred inflation gauge, the Core Personal Consumption Expenditures Index or PCE dropping to 4.4%, the Real Fed Funds Rate is now positive for the first time since 2019 (see chart). A positive Real Fed Funds Rate doesn’t mean a recession is imminent (see chart; we have had long periods of a positive Real Fed Funds Rate and positive economic growth – the shaded vertical bars in the chart are periods of recession). That said, a positive Real Fed Funds Rate should prove a drag on economic growth, and we do expect the economy to weaken as we move through 2023.
The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital Investments, LLC, a registered investment advisor. 340-BCI-2/6/2023