Has the Federal Reserve's policy actually become "loosening"? The San Francisco Fed's new neutral interest rate model provides theoretical ammunition for the hawks.

A study released by the San Francisco Federal Reserve on Monday showed that if we use the mid-term estimate of what is known as the Neutral Rate as a benchmarkwhere borrowing costs neither suppress nor stimulate the economythen the current policy rate set by the Federal Reserve is likely in an accommodative state. This latest research on monetary policy from the San Francisco Fed challenges the mainstream view held by economists and Federal Reserve officials that "the current benchmark policy rate of 3.50%-3.75% is still broadly constraining." This conclusion contrasts with the judgments of most U.S. central bank policymakers, who believe that current monetary policy remains constraining or may have already reached a neutral level. It also conflicts with the picture painted by Federal Reserve policymakers regarding long-term estimates of the neutral rate; according to these estimates, the current benchmark rate range of 3.50%-3.75% could be about 0.5 percentage points higher than the neutral level. Is the Federal Reserve's policy actually "somewhat accommodative"? The San Francisco Fed's new research rewrites the assessment of the neutral rate, adding another crucial variable to the debate over interest rate hikes. However, the new study points out that compared to using policy rules based on mid-term estimates of the neutral rate, employing long-term neutral rate estimates could lead to less favorable economic outcomes. Vasco Curdia, a research advisor at the San Francisco Fed, wrote in the latest issue of the Economic Letter: "The analysis indicates that using this measure to implement monetary policy may stabilize inflation and achieve maximum employment more effectively than standard benchmarks. As of August 2026, the estimate for the mid-term real natural rate suggests that monetary policy is in an accommodative state, although it is essential to keep in mind that this estimate remains highly uncertain." According to the mid-term neutral rate indicator proposed in the paper, the current policy rate target is 0.5 to 0.75 percentage points below a level that would allow the economy to operate at full capacity without slowing down. Federal Reserve policymakers frequently use estimates of the neutral rate to help determine whether monetary policy is tight or loose, and to decide whether to raise or lower interest rates accordingly. Widely accepted monetary policy rules often incorporate long-term neutral rate estimates, which tend to be relatively stable. Policymakers may also reference short-term neutral rate estimates when discussing whether current rates are appropriate, though the latter typically exhibit considerable volatility. The mid-term natural rate estimate proposed by Vasco Crdia of the San Francisco Fed is around 1.5% in real terms, while the actual policy rate, derived from the current nominal policy rate minus about 3% inflation, is only approximately 0.5%-0.75%. Thus, from this model perspective, it appears that the Federal Reserve's policy is indeed in a somewhat accommodative state. This stands in stark contrast to the "tight or close to neutral" judgments reached by most Federal Open Market Committee (FOMC) officials based on long-term neutral rate estimates, although the paper's authors themselves emphasize that the estimate range involves considerable uncertainty. Goldman Sachs is firmly betting on no action for the entire year! The market has shifted from "continuous rate hikes" back to "at most one hike". Examining this study from the regional Fed, it is evidently hawkish in natureif policy has indeed fallen below the neutral level, then theoretically, there is reason for further rate hikes to push real interest rates back to neutral; however, it is a framework for research, not an official signal from the San Francisco Fed or the FOMC for a rate hike. A clearer shift has occurred in market consensus on the expected interest rate: retail sales, employment, and CPI/PPI are forming an increasingly unfavorable evidence chain for hawkish rate hikes. July CPI rose only 0.1% month-over-month; core CPI increased by 0.2%, with year-on-year core inflation dropping to 2.5%; subsequently, PPI came in at 0.0%, significantly below the markets expectation of +0.2%, and year-on-year dropped from 5.5% to 4.7%; compounded with a surprise decrease of 23,000 in July nonfarm payrolls, the rationale for the Federal Reserve to "immediately tighten" has been significantly weakened. Thus, it is particularly interesting that the current market seems to prefer "believing in economic data over this model". Following a series of cooldowns in July's employment, CPI/PPI, and retail sales, the latest data from the interest rate futures market, as of August 18, shows that the probability of a rate hike in September has dropped to around 35%, down from 52.2% a week prior. This indicates that the market is currently betting with about a 65% probability on no action in September. The Federal Funds futures market has only priced in a cumulative increase of about 21 basis points by the end of the year, which is not even enough to fully cover one complete 25 basis point hike. This means that the market trajectory has significantly shifted from concerns in late July about "a return to continuous rate hikes starting in September" to a substantial retraction to "most likely no action in September, retaining a tail risk for a hike by the end of the year." Moreover, a recent Reuters economist survey conducted from August 12 to 17 was even more dovish: the vast majority of respondents expect the rate to remain at 3.50%-3.75% through the end of 2026. The latest retail data also makes the prediction logic of Goldman Sachs senior economist Matheus Dibo, who claims that the Federal Reserve will take no action for the year, more persuasive than just a few days ago: the current key issue is not that inflation has returned to 2%, but whether prior supply shocks from oil prices and tariffs have led to a genuine "second-round effect". Dibo believes that there is still room for downward pressure on housing inflation, the labor market is not overheating, and that a wage-price spiral has not formed; thus, the Federal Reserve has the time to wait for more data, and the latest CPI/PPI further reinforces this judgment. Notably, this is not an isolated contrarian view from Goldman SachsBloomberg Intelligence previously conducted a consultation and survey of economists, revealing that the median prediction still expects the Federal Reserve to maintain interest rates unchanged for the remainder of 2026. In contrast, FOMC voting members Harker, Kashkari, and Logan advocated for a 25 basis point hike in the 9-3 vote at the July FOMC, and they still believe that current policy has not imposed enough constraints and that "action is needed now". Goldman Sachs chief economist Jan Hatzius' latest prediction indicates that unless there is a dramatic reversal in U.S. economic data released before the September meeting, a rate hike in September is "very unlikely". Jan Hatzius's team of economists noted in their latest report that given the cooling inflation in the world's largest economy, the market's bets on Federal Reserve rate hikes are still too aggressive, stating, "Due to weak U.S. retail sales data, disappointing employment data, and slowing inflation data, the likelihood of a rate hike at the Federal Reserve's September meeting is very small."