– ‘No Compelling Argument’ For Big Move In the Beginning of Firming Process
– Affirms Market Expectations of ‘More Normal’ Funds Rate of 2-2.5% by end 2023
– MBS Sales Should Only Be Considered ‘Down The Road’
– ‘Confident’ Fed ‘Can Manage the Soft Landing’
By Steven K. Beckner
(MaceNews) – New York Federal Reserve Bank President John Williams came out firmly Friday against raising the federal funds rate by a half percentage point as an initial move after two years near zero.
Williams, who is vice chairman and perennial voter on the Fed’s policymaking Federal Open Market Committee, also indicated he basically agrees with market expectations that the funds rate will be moved up to a “more normal” level between 2% and 2.5% by the end of next year.
Williams also told reporters he wouldn’t favor selling agency mortgage backed securities from the Fed’s voluminous bond portfolio until sometime “down the road.”
He emphasized the need for the FOMC to move “predictably” and “transparently” as it tries to “restore balance” and lower inflation so as not to be “disruptive” and to achieve a “soft landing” of an economy he described as “strong.”
The strength of the economy and the labor market “takes some of the heat off” of the FOMC as it withdraws monetary stimulus, he said following a webinar sponsored by the New Jersey City University, Guarini Institute for International Education and Economic Mobility.
The FOMC left monetary policy unchanged on Jan. 26, but concluded that both its inflation and maximum employment goals had been achieved. So the FOMC stated it “expects it will soon be appropriate to raise the target range for the federal funds rate,” seemingly implying it will lift off from its zero to 25 basis point target range at its March 15-16 meeting.
The FOMC also announced it will end its asset purchases (“quantitative easing”) in early March, and it released a preliminary set of “Principles for Reducing the Size of the Federal Reserve’s Balance Sheet” in preparation for trimming the Fed’s $8.9 trillion balance sheet.
There has been much speculation that the FOMC will “lift off” with a 50 basis point rate hike on March 16, and bond yields have reflected market expectations that the FOMC will move the funds rate up to neutral territory much faster than previously projected.
Williams, one of Chairman Powell’s top lieutenants and the policymakers and the closest to financial markets, made clear he does not favor starting the firming process with a 50 basis point hike.
“We have clearly opportunities to take policy actions…,” and “we have the ability to adjust policy over the rest of this year and in the future,” he said. “Personally, I don’t see any compelling argument for taking a big step in the begininng – to do something extra in the beginning…”
Rather, Williams said, “we can move steadily up interest rates’ and assess how much higher rates need to go at each FOMC meeting. “I don’t see a need to move really fast at the heginning. I don’t think that’s really necessary.”
At the December FOMC meeting, FOMC participants’ median projection was for the funds rate to be 0.9% at the end of 2022; 1.6% at the end of 2023, and 2.1% at the end of 2024. The FOMC estimates the “longer run” or “neutral” funds rate at 2.5%.
With inflation readings steadily worsening since December, market expectations for funds rate hikes have mounted substantially, and a number of Fed officials have echoed that sentiment.
Beyond Williams did not dispute expectations of the funds rate moving toward neutral next year, but gave no indication he would favor going beyond “neutral” into restrictive territory.
“When I look at market expectations of monetary policy I see a basic pattern that makes sense… of moving from zero back to what we think of as a more normal federal funds rate of 2 to 2 ½ by end of next year.”
Further affirming market expectations, Williams declared, “we’ll be moving basically in a series of steps to move interest rates from very low levels up to more normal levels over time.”
He also noted that the anticipated path to neutral is “more front-loaded this year.”
Williams said he “would say something” if he thought market expectations were going “in the wrong direction.” But he said the funds rate path implied by things like two-year yields look “reasonable” to him.
As for taking back some of the “quantitative easing” the Fed has been doing through massive bond purchases over the last two years, Williams said the Fed’s balance sheet is “significantly larger than you need in an ample reserves regime.”
So “we do have room to reduce the balance sheet. more quickly than we did before…,” he said, adding that Fed bond holdings should be brought down “steadily and predictably.”
Williams said the FOMC does want to eventually get to an all-Treasury bond portfolio, but made clear he does not favor selling agency MBS to accomplish that in the near term.
“I don’t see the need to do that in the near term,” he said, adding that MBS sales should only be considered “later on, down the road.”
Williams said he has raised his forecast of PCE inflation this year to 3%, because “demand is outstripping supply.”
But he said the Fed can reduce inflation without badly damaging the economy as he responded to questions from webinar participants.
Saying the FOMC “need(s) to stick to as predictable a policy as possible” and “keep an eye on keeping the economy strong,” Williams said that currently the economy is “fundamentally in a very good place” and “the labor market is strong.”
So he said the Fed is “in a good position” to withdraw monetary stimulus. “That takes some of the heat off (the Fed in trying to reduce) inflation rather than trying to weaken the economy.”
“I think we can manage the soft landing…,,keeping the economy in a strong place and growing” while the Fed seeks to “restore more of the balance sand stability where demand is relative to supply….,” he added.
Earlier, in prepared remarks, Williams seemed to suggest that the Fed can manage, through “steady” rate increases, to bring down inflation without undue damage to the economy — the classic definition of a “soft landing.”
“(W)ith today’s strong economy and inflation that is well above our 2 percent longer run goal, it is time to start the process of steadily moving the target range back to more normal
levels. In particular,” he said. “I expect it will be appropriate to raise the target range at our upcoming meeting in March.”
“Once the interest rate increases are underway, the next step will be to start the process
of steadily and predictably reducing our holdings of Treasury and mortgage-based securities…,” Williams continued. “Assuming the economy develops roughly as I expect, I foresee this process getting started later this year.”
Inflation, as measured by the consumer price index, has accelerated to a 7.5% year-over-year pace, but Williams seemed to suggest that the Fed can get it under control without too much difficulty and without crashing an economy, which he described as showing “remarkable
strength and resilience’ despite the Covid pandemic.
He said the acceleration of price increases “reflects a unique set of circumstances that has driven
supply and demand out of balance.” He cited a “surge in demand for goods,” “supply-chain bottlenecks and shortages” and a “large pullback in the number of people willing and able to
work.”
With the labor market “already very strong,” Williams said the Fed’s task is simply to “restore the balance between supply and demand and bring inflation down.”
The Fed will have help in achieving this “rebalancing,” according to Williams. “First, with the omicron wave now ebbing and COVID vaccines and treatments much
more widely available across the globe, we should see a gradual restoration of supply and a
resolution of associated bottlenecks and shortages. Over time, consumers should also start to
cut back on buying goods that are in short supply and switch back to in-person activities like
travel, dining, and entertainment, where supply is less constrained overall. Together, these
developments should contribute to more balance between supply and demand in the economy.”
What’s more, Williams said fiscal policy “is unlikely to be as significant a source of demand this year.”
The role of monetary policy is to assist those other factors in “bringing demand in balance with supply and thereby bringing down inflationary pressures.”
A combination of rate hikes and balance sheet reduction “should help bring demand closer to supply,” he said, noting that “financial conditions have already responded based on the expectation of Fed action.”
Williams said he is “confident we will achieve a sustained, strong economy and inflation at our 2 percent longer-run goal…. (M)y forecast for the U.S. economy is for real GDP to grow a bit below 3 percent this year, for the unemployment rate to end the year around 3-1/2 percent, and for PCE price inflation to drop back to around 3 percent, before falling further next year as supply issues continue to recede.”