According to Blockworks, there is ongoing confusion regarding the Federal Reserve's potential decision to cut interest rates in December, despite indicators suggesting a robust economy. The Atlanta Fed's GDPNow model forecasts a 3.3% real GDP growth rate for the fourth quarter, with signs of accelerating growth. Inflation appears to be rebounding, and financial conditions are as loose as they were during the buoyant period of 2021. Despite these positive economic signals, the Federal Open Market Committee (FOMC) maintains a 70% probability of cutting rates this December, leaving many puzzled.

The primary reason for this anticipated rate cut is the Fed's prior guidance to the market, which suggested a December cut. Reversing this guidance could disrupt market expectations. The more intriguing aspect lies in the rationale behind this guidance, which is linked to the neutral interest rate, known as r*. Since r* cannot be directly measured, the Fed relies on models to estimate it. Two prominent models are used: the Lubik model, which is dynamic and statistical, and the Williams model, based on traditional macroeconomic principles. The Williams model, favored by the Fed due to its creator John Williams' current role as NY Fed president, suggests that monetary policy remains highly restrictive. In contrast, the Lubik model indicates that policy might already be neutral.

Market signals, as observed in various economic indicators, suggest a highly accommodative policy environment, challenging the Williams model's assessment. This discrepancy has led to discussions among FOMC members about the true neutral rate, with some, like Austan Goolsbee, advocating for a more empirical approach to determining neutrality. Despite these debates, the FOMC appears committed to the Williams model, driven by bureaucratic inertia, making a December rate cut the likely outcome. This decision comes amid record-high market performances, further complicating the narrative of a restrictive monetary policy environment.