By Steven K. Beckner
(MaceNews) – While there are no compelling reasons at this time for the Federal Reserve to raise interest rates, it must be ready to do so if signs of inflationary “overheating” or financial excesses emerge, Atlanta Federal Reserve Bank President Raphael Bostic said Wednesday.
Like several of his colleagues on the Fed’s policy-making Federal Open Market Committee, Bostic said he is open to holding interest rates steady throughout 2020, but in no sense was he complacent. Stressing that policy-makers need to stay alert to price pressures and threats to financial stability, he made clear there are circumstances that would lead him to favor raising them.
Bostic, in an exclusive interview, withheld final judgment on the economic impact of the U.S.-China “phase one” trade deal inked earlier that day. But he said that pact, together with the U.S.-Mexico-Canada Trade Agreement, have reduced likely downside risks to the economy.
In fact, he asserted, “there is at least as much upside risk as there is downside.” The vicissitudes of President Trump’s trade wars have bedeviled business and the Fed for the past two years. It was trade policy uncertainty that in good part led to the FOMC’s decision to first stop raising the federal funds rate and then to cut it three times from July to October last year to the current target range of 1.5% to 1.75%.
So it was a timely opportunity to chat with Bostic on the very day Trump signed a Phase 1 trade deal with China and on the eve of anticipated Senate passage of the U.S.-Mexico-Canada Trade Agreement.
Bostic, who will return to the ranks of FOMC voters next year, was cautious about what these trade pacts might mean for the U.S. economy, but he was hopeful that they would at the very least reduce downside risks to the outlook and improve the prospects of an economy which he described as already “robust.”
Bostic was not prepared to anticipate how monetary policy might need to respond, but he strongly suggested that if the economy were to go beyond robustness into an “overheated” state, the Fed might have to tighten credit at some point, especially if there were accompanying signs of financial instability. Or asset price inflation. Even apart from trade uncertainties, Bostic was very upbeat about the economy.
“In 2019, we came in a little stronger than our model had projected, and so we were pleased with that performance, and my expectation is that 2020 is also going to be a little above the long-run potential,” he said.
Bostic regards long-run potential GDP growth as “an important benchmark for assessing the appropriate policy stance.” He said he estimates potential at 1.8% to 1.9% and said he is projecting actual growth of 2.0% to 2.1%, “which is a little softer than what we had seen but still above that long-term potential.”
How might the trade deals affect growth? Bostic wasn’t prepared to make a definitive judgment but was hopeful.
“My take at this stage is really to wait and see sort of what businesses decide to do in the wake of this,” Bostic said. In the past two years, Bostic said, business contacts “have really emphasized that uncertainty is one of the important features to emerge out of this recent era.”
Now, despite the inking of the U.S.-China trade deal and the impending USMCA, he said there is still “some clear uncertainty about what the rules will be, but there’s also just a base level of uncertainty about the stability of the rules and whether we will see the changes which happened right now be the rules of the road for a while or whether this is a pause in the midst of continued jockeying and positioning in the trade policy space.”
“For the USMCA, the answer is a little clearer,” he continued, but “this Phase I deal, I don’t know. There’s still a lot of contention that’s not been resolved by this, and I think we will need to continue to monitor what these developments look like.”
“We will have to see how businesses assess these changes to really get a good sense of whether they start to make decisions as if uncertainty has resolved itself or whether there is still a degree of hesitancy, we see that could inhibit investment decisions and the like.”
Bostic is “keeping an open mind on this and not locking into any particular viewpoint until we talk to businesses and see how they respond.”
He said that, “on paper,” less uncertain firms should increase investment, “but we also know that a lot of businesses have been reexamining their supply chains, and how they go about executing business plans and what those business plans are.”
“I don’t know that we’re really going to see those kinds of changes and that dynamics change fundamentally,” he went on. “So I do think there are some open questions.”
But while uncertainty has not been banished, Bostic allowed that “non-exacerbation is a good development.”
“So I would say that the trajectory of risk has changed; I don’t know about the level.”
“I understand there’s still substantial tariffs that still exist on a lot of products that will continue to be a drag on the economy and economic performance,” he noted, “and so until I get a clearer sense of
what’s in this deal and what it means and what the resulting tariff environment is it is hard to say that things are better.”
“Actually, it’s hard to quantify how much better things are, but we know for sure they haven’t gotten worse, and that’s a good thing for everyone from a psychological perspective,” he said.
Bostic did not think downside risks predominated before the trade deals, he indicated. “I’ve been of the view that the risks have been close to balance for some time.”
If anything, he suggested, upside risks are now more dominant. “Many in the business community have really adapted to the conditions and have built strategies that they believe will be resilient
in the face of a range of potential different realities,” he said. “And because of that and hearing more and more comfort from businesses that their models are going to be able to weather a bit of whatever turmoil is to come and that confidence has got me thinking very much that there is at least as much upside potential as downside,” he asserted.
The trade deal with China, the USMCA and the prospect of the UK completing “Brexit,” ending that source of uncertainty, are “all things that point in the way of upside risks, and that’s really a counterbalance to the narrative of recession risks that I’ve seen in the media.”
“That really leads me to feel comfortable that we’re in a really balanced place.”
That being the case, Bostic was asked when the FOMC should start taking back some of its 75 basis points of easing.
Bostic replied that he will be guided by “a couple of metrics.” “One of them is inflation, and to the extent we get signals that inflation is moving in a robust way that would suggest the economy has actually gone beyond a steady state and might be in an overheating perspective, that is one metric I would look to.”
“But I would also actually worry a lot about just signs of risk,” he went on. “To what extent are we seeing a return of financial instruments that expose the economy to significant risk,” he said, recalling that the last recession was triggered by risk-taking in newer financial instruments.
“I worry a lot about that and I’m going to be sure that I keep my mind and my focus on developments that suggest we may return to those things.”
“I’m not seeing that today,” he added. “I’m not seeing lenders investing in high leverage ways that could suggest that if things don’t turn out as projected there could be a significant crash in the financial sector, but I definitely worry about that, and I want to make sure that we don’t miss those signals as we are thinking about what the appropriate stance of policy looks like.”
The Fed’s mandate is to target inflation, not asset prices, but Bostic said the latter is “definitely something we have to be mindful of. I think it we start seeing any of those metrics get far outside the boundaries of what we have seen as the boundaries of variation that should at least get attention and force us — force me — to think about
what does it mean, what are the risks of getting to these levels and to what extent might we need to think about acting on this.”
“I think we absolutely have to be thinking in that way,” he added.
Bostic was not prepared to say when the FOMC might need to consider raising rates, saying he will be guided by “experience” and “mak(ing) sure we’re responding to real trends as opposed to one-off data points.”
The Fed’s policy “horizons are going to be in the quarters more than months,” he said, adding that he plans to “look through” monthly data fluctuations and “idiosyncrasies.”
Might the FOMC hold rates steady all year, as some of his colleagues have suggested?
“I am open to that possibility,” Bostic responded. “I don’t think there is a mandated imperative to do something in the policy space.”
“If the economy’s performance doesn’t call for it (tightening), I would be fine with that,” he added.
“What we’ve seen in the last year, year, year and a half, is an economy where the consumer has stayed quite strong, and where investments have continued at a pace that suggests growth can continue at this pace for some time, and as long as this holds I don’t think there is a need at all for us to have to do something,” he elaborated.
“So if it stays where we are and the economy continues to perform that way, I’d be comfortable just staying there,” he said.
Reemphasizing his two “metrics” for raising rates, Bostic said “inflation is one. Absence of risks being taken by potential speculators or by financial markets would be another.”
“This a multi-dimensional thing…,” he continued. “We should be ready for the unexpected, and we should be positioning ourselves as much as possible to respond to whatever dynamic emerges when it does.”
“So I’m keeping my eyes open and my mind pretty uncommitted in terms of focusing or anchoring on any one statistic to be ready for whatever comes,” he added.
Were the Fed to raise rates relative to those of its trading partners, the resulting exchange rate effect could affect U.S. competitiveness. But Bostic said, “our policy really has got to work for us — for our businesses and consumers. That’s really going to be my largest consideration in thinking about the relative competitive position of the business sector ….”
“I’m not in a place right now where I think that specific moves on our side would be a radical, key driver of a competitiveness change…,” he said, adding that not just exchange rates but also fiscal and tax policies also matter. “So all these things need to be taken into consideration.”
Another factor the FOMC might well need to take into account when weighing whether to raise rates is the funds rate’s current close proximity to the zero lower bound and the need to rebuild a rate buffer to give the Fed more room to ease in the event of a downturn, Bostic said.
But he stressed that widening the gap between the funds rate target and the zero lower bound must be consonant with meeting the Fed’s economic objectives.
“Sure, in all these things having more space is preferred to having less,” he commented. “As much as we can accomplish that while preserving the stability of better economic performance in the country we should totally be trying to accomplish that.”
“I think the first goal, though, should be to make sure the policies we’re pursuing and the stance of our policy is positioned to insure that the economy will continue to perform at a solid level, and I think we’ve accomplished that. So that’s a good thing.”
Elaborating on the importance of financial conditions in assessing the appropriate monetary policy stance, Bostic said he and his colleagues are “really trying to get a much clearer handle on … to what extent do they represent really fundamental changes in the amount of risk in the system.”
“I ask this question all the time, and in most instances I am not getting responses that suggest we’re seeing an explosive new introduction of risk that we should worry about systemic concerns,” he said. “But it’s definitely something I’m paying attention to and thinking about whether these valuations are inducing decision making that could entail a fair amount of risk.”
“If I start to see that I will be concerned, but to date I am not getting a sense that that has gotten out of control.” Bostic said he “think(s) a lot about what’s happening in the tech sector to make sure valuations and prices are staying commensurate with profitability.”
“I do think there are some really important questions to ask, about where sources of funds are being diverted so that yields that are lower in bond markets are driving capital into equity markets that could lead to some exposure of institutions as well as households. So I think that we just need to be mindful of any development where there’s risk.”
In other comments, Bostic said he is “still studying” whether a permanent repo facility should be created to cope with the kind of money market pressures that developed last September. He said some changes in the discount window might be in order to make banks more willing to borrow directly from the Fed.