US Economics Weekly: North America: Much ado about neutral

This is Morgan Stanley's US Economics Weekly (North America), focused on the neutral rate and financial conditions. Our models show the real neutral rate has risen from under 100bp since 1Q25 to about 150bp, suggesting current policy is neutral to modestly restrictive rather than accommodative, so the Fed does not need to play catch-up. We use two approaches: a FRBUS-based model and a PCA model. The FRBUS index shows financial conditions have tightened by 100bp since February, driven primarily by higher 10-year Treasury yields (103bp), with the dollar and oil contributing 34bp and 6bp, while equity returns and BBB credit spreads offset 42bp and 2bp. The PCA index stands at 0.78 standard deviations above its historical average, indicating conditions are tighter than normal but only moderately so. We maintain our view for two more 25bp hikes in December and March, to a target range of 4.25%-4.5%. We expect September core CPI at 0.24% m/m and headline at 0.62%, in line with core PCE at 0.