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Evercore ISI offers outlook for fed funds rate in each scenario By Investing.com

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Although interest rates are at high levels, the economy has not weakened in the way many expected. In a research note, Evercore ISI examines the impact of the Fed's fiscal policy on interest rates, noting that compared to the pre-Covid baseline, it is likely still stimulating the economy.

In other words, the analysts wrote, “fiscal policy has pushed the neutral short-term interest rate higher.”

However, the impetus from fiscal policy is likely to moderate over the next 12 to 18 months, which will lead to lower inflation in the short term.

Evercore's analysis used a measure of the impact of fiscal policy by the Hutchins Center for Fiscal and Monetary Policy. Using this, they find that fiscal policy still boosts the economy by the equivalent of 0.7% of GDP compared to the 2019 baseline. This estimate includes effects through household or business spending.

“If the Fed were to set policy to fully offset this stimulus, it would need to engineer long-term interest rates — such as the 10-year Treasury yield — about 25 basis points higher than they were in 2019,” analysts wrote in Newsweek. . NB.

This entails setting the federal funds rate at about 70 basis points above other rates.

An additional approach used by Evercore to determine the impact of fiscal policy is an assessment based on an “optimal control” model. In order to offset today's fiscal stimulus, this approach suggests that the federal funds rate would need to be about 125 basis points higher than if there had been no stimulus.

This would explain why the policy does not seem very restrictive today, analysts note.

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Both approaches also suggest a timeline for when the impact of fiscal stimulus will be offset. According to the Hutchins-based measure, the federal funds rate to offset the stimulus will fall by 70 basis points by the end of 2025 (starting to decline by mid-2024).

Under the optimal control method, the increase in the federal funds rate would decrease by 100 basis points by the end of 2025.

“This suggests that cuts of 70 basis points to 100 basis points may be needed until the end of next year to offset fading fiscal support and the associated decline in the short term, separate from other considerations that will shape the interest rate path,” the analysts added.

Biden vs. Trump

The report also addressed the repercussions of the US elections on financial policy. More importantly, Trump's first-term tax bill is set to expire at the end of 2025.

If he becomes president again, the Tax Cuts and Jobs Act will likely be extended; Meanwhile, Biden will partially repeal the law.

Biden's approach is estimated to result in a federal funds rate 25 basis points lower than if the TCJA had been extended under Trump.

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