- ‘Dramatic’ Job Gains, High Inflation Means ‘Approaching’ Liftoff
- Doesn’t Expect Steep Rate Hikes; Rejects ‘Extreme Scenarios’
- Funds Rate Should Go ‘Somewhere Above 2% Down The Road’
- Unclear How Long After Liftoff Balance Sheet Shrinkage Will Start
- Not As Long As Last Time
By Steven K. Beckner
(MaceNews) – New York Federal Reserve Bank President John Williams strongly suggested Friday that the Fed is getting close to raising short-term interest rates, given “dramatic” labor market improvements and unacceptably high inflation.
Williams, one of three top monetary policymakers, said that after the Fed stops buying bonds to depress long-term rates, the preferred sequence should be “liftoff” of the federal funds rate from the zero lower bound, followed by shrinkage of the Fed’s bloated balance sheet.
While the FOMC is “approaching” liftoff, he was vague about the timing of balance sheet reductions when talking to reporters following an address to the Council on Foreign Relations. He did say it would come much sooner than in the last monetary tightening cycle, when the Fed waited more than a year to incrementally raise the funds rate and another two years to start running off maturing securities in the Fed’s portfolio.
Williams was also vague about how quickly the funds rate will increase, saying it will depend on fast inflation recedes from the 7% year-over-year pace which the consumer price index registered in December.
“Down the road,” he said the funds rate should rise to “somewhere above 2%” to reflect “normal” money market rates, but said that doesn’t mean the FOMC needs to approve any particular number or rate hikes this year.
He rejected predictions, such as those from his predecessor Bill Dudley, that the funds rate will need to go to 4% or higher.
Williams, perennial voting member and vice chairman of the FOMC, said he and his colleagues will ultimately want to begin “normalization” of the balance sheet from the current $8.8 trillion, but laughed at the prospect of returning to the much smaller level that prevailed in 2007, before the global financial crisis prompted three rounds of quantitative easing.
The FOMC will continue an “ample reserves” strategy, using the payment of interest on reserves and the overnight reverse repurchase facility to manage the funds rate, he said. He repeatedly called the funds rate the “primary” monetary tool, although he said the balance sheet is also “an important tool” at times.
At its last meeting Dec. 14-15, the FOMC doubled the pace at which it is winding down its asset purchases to $30 billion per month with the expectation of ending “tapering” by mid-March.
Beyond that, FOMC participants projected three 25 basis point hikes in the federal funds rate from near zero. Some officials have indicated they favor making an initial rate hike at the March 15-16 meeting. The FOMC is next scheduled to meet Jan. 25-26.
Williams did not explicitly predict a March rate hike, as is widely expected in financial markets, but he said nothing to disabuse that notion. Quite the contrary.
“Because of inflation developments and the notable improvement in the labor market,” the FOMC reduced the monthly pace of its net asset purchases, he noted in prepared remarks. “With our actions, we have started the process of adjusting the stance of monetary policy away from one of providing maximum support for the economy.”
“This movement in policy reflects the gains the economy has made since the beginning of the pandemic and the evolution of the risks to the achievement of our goals,” he continued, adding that “the next step in reducing monetary accommodation to the economy will be to gradually bring the target range for the federal funds rate from its current very-low level back to more normal levels.”
And Williams added, “Given the clear signs of a very strong labor market, we are approaching a decision to get that process underway.”
Responding to questions from CFR webinar participants said “we don’t know exactly the path of the funds rate,” but said that “when we put out our projections at the December meeting..everyone saw rate increases this year and continuing next year. That’s completely sensible.”
“We’ll see about the exact timing and pace of raising interest rates,” but “clearly that’s the path we’re headed to, and it’s completely appropriate,” he went on. To bring down inflation while preserving maximum employment “it does make sense we should remove that accommodation.”
Pressed further on the timing and pace of rate hikes by reporters, Williams continued to point indirectly toward early liftoff, while deferring to the FOMC to discuss and make final decisions.
“We have had such dramatic improvement in the labor market, and inflation is higher than we want,” he said. So “It does make sense (to start raising rates). We’re approaching that kind of decision.”
Williams added that, thanks in part to “successful” monetary stimulus, “the economy is in great place in terms of employment and GDP.” So “it makes sense for monetary policy to evolve as the economy evolves.”
“We’re in a good position to do that in a way that’s not disruptive,” he added.
Asked about how many times the FOMC is apt to raise the funds rate this year, Williams said “there’s a lot of uncertainty,” but said the “baseline view” is that “it’s really about a path back to more normal interest rates… to somewhere above 2% down the road.”
“So it’s really not so much (doing) so many rate increases this year or next year,” he continued. “It’s really about the movement to that over the next year or two … . Any kind of path that would get you toward that is the goal.”
“And like I said, we’re approaching that kind of decision to get that going,” he reiterated. “It’s appropriate to start moving policy in that way, removing accommodation gradually and communicating that’s what we’re expecting.”
Williams said he and his fellow policymakers have “worked hard at trying to do a good job communicating … .The (funds rate projection) ‘dots’ in December sent a pretty clear signal.”
He added that Fed Chairman Jerome Powell also “will have opportunities to communicate our thinking.”
“It makes sense to almost everybody that it would make sense to begin to remove accommodation,” he added.
Asked about Dudley’s comment that the FOMC may need to raise the funds rate to 4% or 5% to get inflation back under control, Williams replied, “That’s not my expectation … where we’re going to be in one of those more extreme scenarios.”
The pace of rate hikes “all depends on how the economy evolves, how inflation evolves,” he said, noting that most financial market participants expect the FOMC to raise rates to only 2% to 2.5%.
Only after the FOMC starts raising the funds rate should it think about shrinking the balance sheet – sometimes “in the future,” in Williams’ view.
“Right now we’re in the process of tapering asset purchases,” he noted in webinar remarks, saying that will conclude in March. “The next decisions about removing accommodation is liftoff, raising the funds rate … . I see the process of (balance sheet) normalization coming after that.”
“As to how to do that in a way that’s predictable is a topic we’ll have to talk about,” he said. The objective will be “removing accommodation but in a way that’s not highly disruptive to markets.”
He said this may “require a lot of adjustments along the way.”
Asked about the likely impact of monetary normalization on financial conditions, Williams said he “would expect that to affect how accommodative financial conditions are … . I would expect them to become less accommodative over time.”
But Williams does not expect a sharp spike in long-term bond yields. Nor does he expect a yield curve inversion.
As the FOMC raises short-term rates, Williams said he would expect long-term rates to go up as well. He said there could be “some flattening” of the yield curve, but said his “expectation is that the whole yield curve will go up.”
He declined to say how long after liftoff the FOMC will start shrinking the balance sheet, but answering his own question, he said, “Are we likely to wait as long as last time? No.”
Contact this reporter: steve@macenews.com
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