Why The Fed Funds Rate Is Too Low

Analysis by Deutsche Bank suggests the Fed is 'overinsured' against labor risks, keeping the funds rate 100-160bps below levels prescribed by the Taylor rule. This creates a significant risk of inflation re-acceleration if downside growth risks do not materialize.

Key Takeaways

• 1.The federal funds rate is currently approximately 100-160bps lower than what is prescribed by standard policy rules like the Taylor rule and the 'balanced approach' rule.
• 2.The Fed is considered 'overinsured' against labor market risks, having conducted risk-management cuts in 2025 that now appear overly accommodative relative to a re-acceleration in inflation.
• 3.Maintaining this accommodative stance poses a high risk of significantly higher inflation if labor market downside risks (like AI-driven layoffs) do not materialize.

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