Coming from the chair, Warsh's spin on how policy is affecting the economy was eye-catching because it challenges a long-standing assumption among many Fed officials that rates remain slightly "restrictive." If the Fed rethinks the "neutral" rate that's neither spurring nor dragging on the economy, it will almost certainly land higher than current levels, and markets may well be shifting their own "real rate" horizon accordingly.
The median of quarterly Fed policymaker forecasts for the long-term nominal policy rate comes in at 3.1%, widely seen as a proxy for "neutral." But this assessment can change materially: it has already risen from 2.4% in 2022 and stood as high as 3.8% as recently as 2015. Fed models suggest the real neutral rate - "R-star" - is anywhere from 1.0% to 1.65%. Adding a 2% inflation target implies a nominal rate close to the current rate at the upper end of that range.
But with real Fed policy rates - measured against prevailing headline PCE inflation - still effectively zero, the Fed does not appear to be dragging on the economy in any material way - if anything, it may still be stimulating growth even as AI-spurred growth, inflation, investment and financial conditions all suggest otherwise.
With chip giant Nvidia indicating last week that the AI capital-expenditure boom will continue at least through next year - and its sales are expected to rise another 70% in 2028 - the nature of the global economy is potentially shifting, forcing another look at neutral rate models. At the very least, corporate borrowing is rising sharply, and the U.S.-focused data-center boom is also likely to fan out well beyond American borders in the coming years.
Even if you're optimistic a productivity boost ensues to allow the economy to grow faster, the buildout and investment phase will put upward pressure on the cost of capital as savings and investment rebalance. Warsh himself nodded to this in comparing the boom with the stagnant years of a savings glut, when no one wanted to invest and interest rates fell to zero.
As an example of how the AI race is lifting global activity despite a year of U.S. trade wars, the Organisation for Economic Co-operation and Development last week said G20 goods trade accelerated through the second quarter. Quarterly import growth rose to 6.7% from 5.2% in the first quarter, with AI-related chips and computing equipment accounting for a large part of the pickup.
TLT•
