By Steven K. Beckner
— Despite Strong Data ‘Just In Beginning Stages’ of Recovery from Covid
–‘Going to Need Repeated Months’ of Strong Data to Change Policy
(MaceNews) – San Francisco Federal Reserve Bank President Mary Daly said Thursday that, while recent economic data have been “hopeful,” they are not nearly enough in her mind to justify a reconsideration of the Fed’s aggressively easy monetary policy.
Daly, a 2021 voting member of the Fed’s policy making Federal Open Market Committee, hailed recent strong employment, retail sales, industrial production and other data and said she expects “a big, big rebound” in the second half.
However, like other Fed policymakers, Daly strongly indicated she thinks it is much too early for the FOMC to firm monetary policy at its meeting later this month or even at subsequent meetings.
She said the FOMC is “a long way” from achieving either its maximum employment or its 2% average inflation goals and will need to see “repeated months” of strong data before even considering a less accommodative monetary stance.
At its March 16-17 meeting, the FOMC left the federal funds rate in a zero to 25 basis point target range and said, “It will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time.”
And the FOMC said it would continue buying $120 billion of bonds per month “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.”
Asked by a webinar participant to define the “substantial further progress” needed to taper bond buying, Daly said, “We we need to see things moving toward the goals we have.”
“We’re not there yet,” she asserted. She made the same point with even greater emphasis to reporters.
Noting that “almost 9 million people are out on the sidelines … who had jobs before” the pandemic, she said, “We’re pretty far away from substantial further progress” toward the maximum employment side of the Fed’s dual mandate.
Daly acknowledged that inflation is rising but “only temporarily,” so she said, “We’re far away from that (average 2% inflation target) as well.”
“We need to get closer to our goals…,” Daly said, adding that she and her fellow policymakers need to “see that we’re well on our way toward our goals before we start thinking about withdrawing any kind of accommodation.”
On Wednesday, Chairman Jerome Powell said the economy seems to be at “an inflection point” as he referred to the near one million non-farm payroll gain in March. Thursday morning, the Commerce Department reported a 9.8% leap in retail sales, while the Fed announced a 1.4% increase in industrial production, and the Labor Department reported that initial jobless claims plunged in the latest week.
Asked by Mace News how much more of such data the FOMC needs to see before it reconsiders its policy stance, Daly responded that, “We have some very hopeful data.” She attributed the rise in retail sales to the fact that “people are coming out of their houses” and spending money after a year of lockdowns.
But she added, “We’re just in the beginning stages” of recovery from the pandemic. “We’re going to need repeated months” of strong data before the FOMC “can distinguish” between a short-term snapback in growth and a longer term sustainable expansion.
“Optimism and data are not the same thing,” she went on. “I’m hopeful, bullish, but I want to see it in the data before we change policy.”
Daly said she is expecting “a big, big rebound in the second half,” but thereafter she predicted growth will “moderate.”
As for concerns about inflation rising too fast in an “overheated” economy, she nearly scoffed. “We’re so far away from that scenario.”
Echoing comments made by Powell and others, Daly suggested the below-target inflation “dynamics” that have prevailed since the 1970s insulate the Fed against a break-out of inflation. She said the Fed “has the tools” to contain inflation if needed, but that getting inflation higher has proven problematic.
Referring to the FOMC’s revision of policy framework last August, Daly remarked, “Nowhere in that document did it say we’d let inflation run unbridled.”
“We will ensure inflation won’t run away,” she promised. The 1970s was “a frightening time,” she conceded, but, “We’re not in that situation now.” She also said she sees no “worrisome” signs of wage gains, suggesting indeed that more would be welcome.
The Fed’s approach to its inflation target is symmetrical, she stressed. “If inflation goes too low we’re going to boost it, if it’s too high we’re going to pull it back.”
For now, “there’s a lot of work to do to return the economy to price stability and full employment,” she said, later adding, “We have a long way to go before we’re fully back.”
In earlier prepared remarks, Daly expressed concern about the financial system’s increasing reliance on the Fed as “lender of last resort” in a climate of endemic low interest rates that are causing financial firms to “reach for yield.”
Referencing the extraordinary actions the Fed took a year ago with the onset of the pandemic, she said, “the Federal Reserve’s role as lender of last resort will always be a critical backstop in the protection against turmoil and dislocation caused by rare or extreme events. But to fulfill the role sustainably, we need to be the last, not the first, line of defense.”
“Regularly relying on ‘save the day’ interventions by the Federal Reserve can be costly, resulting in public losses and undesirable risk-taking on the part of the private sector,” she added.
Daly said that “as we begin to emerge from our battles against COVID-19, it is time to focus on crafting more complete policies that leave us better prepared to weather future storms, big and small.”
Part of the problem, she told the Money Marketeers, is a global decline in r* – the natural real short-term interest rate – which has in turn forced the Fed to lower the short-term rates it controls.
“Lower neutral rates of interest also mean that the Federal Reserve and other central banks, constrained by the effective lower bound on interest rates, need to routinely employ ‘low-for-long’ policies to achieve mandated employment and price stability goals,” she said.
Daly said these low rates “can put pressure on the business models of financial institutions, leading them to reach for yield, which can jeopardize the stability of the financial system.”
She cited as a related concern the financial system’s “broad-based increase in debt levels and leverage ratios.”
The Fed and other regulators must also confront Treasury market issues,” said Daly.
“Given the growing size of the Treasury market, and the potential inability of broker-dealer balance sheets to keep up, this intermediation channel could face more capacity pressure in the future,” she warned.
Referring to the market strains of last March, Daly said “a number of possible reforms” could be made.
“These include the Federal Reserve creating a domestic standing repurchase facility to backstop markets in times of stress and making permanent the temporary FIMA – Foreign and International Monetary Authorities Repo Facility – to help support smooth market functioning,” she said, adding, “These actions would provide assurance to markets that liquidity will be available in times of stress.”
Daly acknowledged such facilities “could also leave financial markets more dependent on their existence.” So “further careful study is required.”
Daly also suggested “expanding trading platform access to more entities and using central clearing for Treasury cash markets could reduce the burden on broker-dealers and lessen the liquidity crunch in times of stress.”
“Additionally, reconsidering the inclusion of reserves or even Treasuries in the regulatory leverage-ratio requirements for broker-dealers, particularly when markets are strained, could further facilitate capacity for clearing,” she continued.
But she said those changes have potential costs, as well as benefits, “so further careful study is warranted.”
Daly also saw a need for increased macroprudential supervision to guard against excessive risk-taking. “The proximity of the effective lower bound on interest rates and the necessity to keep policy rates low for longer after a downturn, can, … result in reach-for-yield behavior among financial firms. So, we also need to find ways to foster and maintain sustainable increases in leverage.”
—
Contact this reporter: steve@macenews.com.
Content may appear first or exclusively on the Mace News premium service. For real-time delivery in entirety contact tony@macenews.com. Twitter headlines @macenewsmacro.