Pre-Blackout Fed Remarks Don’t Signal Push for Immediate Rate Rise

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The persistence of inflation undershooting the Fed’s own expectations is an “important” consideration for the Fed relative to monetary policy, and “to the extent that the effect on inflation of further gradual tightening in labor market conditions is likely to be moderate and gradual, the case to tighten policy preemptively is less compelling,” Fed Governor Lael Brainard said in prepared remarks in Chicago (link).

Brainard’s remarks laid out five key features in what she labeled the “new normal” for US monetary policy. They include inflation undershooting expectations and the Phillips curve has flattened, labor market slack has been greater than expected, foreign markets matter, the neutral rate is likely to remain low for some time and policy options for the Fed are asymmetric.

While the US labor situation has improved, Brainard noted, “this improvement has been accompanied by evidence of greater slack than previously anticipated.” Given the in the presence of uncertainty and the absence of accelerating inflationary pressures, it would be unwise for policy to foreclose on the possibility of making further gains in the labor market,” she said.

Downside risks are out there in emerging economies, Brainard observed, and such headwinds from overseas “should matter to US policymakers because recent experience suggests global financial markets are tightly integrated, such that disturbances emanating from Chinese or euro-area financial markets quickly spill over to US financial markets.” Plus, the experience also suggests the “fallout from adverse foreign shocks appears to be more powerfully transmitted to the US than previously,” she added.

Regarding the neutral rate which most view as being “considerably and persistently lower” than it was before the financial crisis, Brainard said, “Several econometric models and estimates from market participants suggest the current real neutral rate is at or close to zero, and any increase is likely to be shallow and slow. These estimates imply that it may require a relatively more modest adjustment in the policy rate to return to neutral over time than previously anticipated.”

On the issue of asymmetric monetary policy options or the ability of monetary policy to respond to shocks, Brainard said, “From a risk-management perspective, therefore, the asymmetry in the conventional policy toolkit would lead me to expect policy to be tilted somewhat in favor of guarding against downside risks relative to preemptively raising rates to guard against upside risks.”

Even as inflation forecasts are to the upside, Brainard said it appears that the “response of inflation to unexpected strength in demand will likely be modest and gradual, requiring a correspondingly moderate policy response and implying relatively slight costs to the economy.”

Also speaking today, Atlanta Fed President Dennis Lockhart indicated that he expected “serious discussion” about raising interest rates at the September meeting given the current economic conditions. But he also pointed out that he did not view the current situation as being where “we are incurring the costs of patience that put a lot of urgency on the question of raising rates.”

Lockhart was not specific relative to when he would prefer to see the Fed raise short-term interest rates.

Throwing support behind not moving rates was Minneapolis Fed President Neel Kashkari. “There doesn’t appear to be [a] huge urgency to do anything, frankly,” he told CNBC. Rather, Kashkari’s view is one of getting as much data as possible and try to get inflation back up.

Comments: This trio of Fed speakers appears to have been what markets wanted to hear as US stock indices have rallied today after suffering brutal losses Friday in the wake of comments by Boston Fed President Eric Rosengren that were interpreted as calling for a rate rise at the September 20-21 meeting – a shift from where he typically has been. His remarks had upped expectations that Brainard could also shift her views, but her prepared remarks suggest she is not in the hawk camp yet. So it sets up for a likely steady policy FOMC meeting September 20-21 unless some dramatic shift in economic data unfolds. While some have noted Lockhart’s statement about a “serious” discussion, that has not been viewed as being a call for a rate rise this month. So it would seem we will likely see another split Fed ahead.

NOTE: This column is copyrighted material; therefore reproduction or retransmission is prohibited under U.S. copyright laws.