The Fed's Been Quietly Raising Its Long-Term Interest Rate Forecasts

With inflation cooling from its recent highs, all the focus has been on when the Fed might cut its key interest rate. But, in the meantime, the central bank has been doing a subtle yet crucial thing that a lot of folks have overlooked: raising its estimates for the long-term “neutral” interest rate.

The long-term neutral rate is the amount of interest that keeps the economy roughly in balance – neither too hot nor too cold (barring any unexpected shocks). It’s essentially a stand-in for the r-star, the ideal rate that balances savings and investments without pushing inflation out of control. And it sets the stage for where interest rates are headed.

Over the past six months, Fed officials have nudged their expectations for this neutral rate higher. When we strip out the outliers in their forecasts, the midpoint estimate has climbed above 3% and the median has risen too.

This is still relatively low, but what this tells you is that the era of ultra-low interest rates may be over. And it’s not altogether surprising: after all, the five big trends that are shaping the long-term macro picture – productivity, climate change, aging, multiglobalization, and debt – all point toward a growing need for higher interest rates.

It matters. Interest rates are a huge driver of almost all asset prices – so a shift could have big implications for your portfolio. For instance, investments that thrived over the past decade – like financial assets and growth stocks – could soon take a back seat to real economy plays and value stocks. And small, risky companies with big financing needs could continue to struggle, while high-quality stocks with strong compounding power could continue to outperform, despite their already elevated valuations.

So go ahead and celebrate the cuts to the Fed’s key rate when they happen, but don’t lose sight of the bigger picture – and make sure your portfolio is equipped to handle a potentially very different long-term economic environment.