Inflation and Interest Rates

Let's trace interest rates vs inflation rates.  

Monetary theory suggests that interest rates need to be greater than inflation rates in order to reduce inflation.   Two assumptions: (1) the Fed will raise interest rates (Fed Funds Rate), (2) Inflation, especially as measured by Core-PCE will decrease.  When these rates are equal monetary policy will be close to "neutral", i.e. the real inflation rate (adjusted for inflation) will be zero.

Two questions.   The length of the x-axis, i.e. when will interest rates be neutral; and the value of the y-axis, what will the rates be.

If inflation persists, then the neutral rate may be 4% (or higher) and the Fed will continue to raise rates until the end of 2022 (or beyond).  

If inflation begins to recede then the Fed may stop raising rates earlier and stop at a lower neutral rate, e.g. 3.5% and stop 4th quarter 2022.

Update: Jan 13

Inflation continues to come down and the Fed continues to raise the Fed Funds rate.   Still a way to go.  There is hopeful news.  The job market remains strong even as inflation eases.  This increases the possibility of a "soft landing" meaning that the inflation continues to ease, the Fed stops raising rates and this all occurs without a recession.

Recession can be measured in multiple ways- the primary metric is a decline in GDP but this is of little interest to me.  The more important metric would be a material increase in unemployment.  If we can get inflation down, without a big spike in interest rates, and keep unemployment under 4.5% that would certainly qualify as a soft landing.

As far as the stock market goes there are two factors to consider.  One is the interest rate.  The higher the interest rate the lower the P/E multiple.  So, the questions are what is the terminal interest rate, and how long will the Fed keep the interest rate at that level?

The second is factor is earnings.   Will there be an earnings "recession" which would be defined as a dip in nominal earnings?