By Jerry Kronenberg
NEW YORK (MaceNews) – Dallas Federal Reserve President Robert Kaplan said Wednesday that the central bank has begun closed-door discussions on how to permanently solve the repo market’s liquidity crisis without endlessly intervening and expanding the Fed’s already large balance sheet.
“I believe very strongly that we’re going to need to find a way to curtail the growth in the balance sheet and find other tools” to fix the repo market, Kaplan said during an appearance before the Economic Club of New York.
The Fed has had to inject liquidity into the $1 trillion repo market multiple times since September, when interest rates on repos – short-term loans banks make to each other to meet their needs for cash — unexpectedly shot up. The central stepped in when banks found it both costly and challenging to raise enough money for their short-term needs.
While some blamed the problem on large corporations temporarily needing money to pay tax bills, Kaplan said Wednesday that “my own view is that this is going be an ongoing challenge, because we know government debt issuance is going to continue to climb.” After all, he noted that the U.S. government’s total debt is running in the trillions of dollars.
The Dallas Fed chief told reporters after his talk that the central bank has already begun “private discussions” on a permanent fix to the repo problem. Although he declined to discuss details, Kaplan said “it would be healthy to get to a point where we certainly don’t have to do these daily interim operations.”
He and other Fed members have warned that continuously increasing the Fed’s balance sheet could create big market risks. Kaplan and others have noted that as the Fed’s balance-sheet growth drives down interest rates on U.S. Treasuries, institutional investors are increasingly making riskier, higher-rate business loans as a way to get higher returns.
“High-yield loans have grown dramatically, and I have expressed concerns about it,” Kaplan said. “I don’t think at this point it’s a systemic risk … but it’s likely to be an ‘amplifier’ [in] a downturn. If we start growing more slowly because businesses are so highly leveraged, they’re going to allocate more of their cash flow to servicing their debt rather than investing in their businesses.
The Dallas Fed president called the central bank’s large balance sheet “one of several factors that I think may be exacerbating the valuation of risk assets … and it just reminds me that the Fed balance sheet is not free, and growing the balance sheet has costs.”
Kaplan said the central bank should treat financial-market stability as almost a third leg to the Fed’s “dual mandate” of setting interest rates in such as way as to maximize U.S. employment while keeping inflation under control.
“It’s not [officially] a third criterion, but … financial stability has got to still be a consideration,” he said.
In other remarks, Kaplan said:
· He expects the U.S. economy to expand about 2% to 2.25% in 2020, “similar to what it grew in 2019.” The central banker said the recent U.S.-China Phase 1 trade deal and the likely ratification of the U.S.-Mexico-Canada trade agreement should help both American and worldwide economic expansion. “Global growth will still be sluggish, but somewhat better [than in 2019],” Kaplan said.
· The Dallas Fed chief warned that high U.S. government debt, an aging workforce, insufficient immigration of workers with certain needed skills and inadequate education of future workers threaten to sap America’s economic potential. “Growth is sluggish, and I think it is going to continue to remain sluggish unless we take certain actions,” he said.
· The December U.S. employment report released last Friday was “a healthy jobs number … consistent with a solid, strong labor market,” even though the economy created only 145,000 non-farm jobs vs. the 160,000 many analysts had expected. However, Kaplan warned that “it would not surprise me to see the level of job growth tail down somewhat in the coming months, because we’ve got [a] very tight labor market right now.”