By Steven K. Beckner
EFFINGHAM, ILL. (MaceNews) – St. Louis Federal Reserve Bank President James Bullard. warning an already slowing economy could continue to slow more than expected, strongly suggested Monday that more credit easing is needed, but said it is possible the Fed will be able to “take back” some or all of its “insurance” interest rate cuts.
Bullard, a voting member of the Fed’s policymaking Federal Open Market Committee, noted the economy has slowed and said “the economy faces downside risk that may cause the slowdown to be sharper than expected.”
Bullard was one of three Federal Reserve Bank presidents who voted against the FOMC second 25 basis point rate cut last week, preferring a 50 basis point cut instead. The two other dissenters, Boston’s Eric Rosengren and Kansas City’s Esther George, opposed cutting rates at all.
Bullard stopped short of predicting further Fed rate cuts, telling the southern Illinois town’s chamber of commerce, “The FOMC may choose to provide additional accommodation going forward, but decisions will be made on a meeting-by-meeting basis.”
He was more emphatic in justifying his dissent in a statement Friday. “First, there are signs that U.S. economic growth is expected to slow in the near horizon. Trade policy uncertainty remains elevated, U.S. manufacturing already appears in recession, and many estimates of
recession probabilities have risen from low to moderate levels.”
“Moreover, the yield curve is inverted, and our policy rate remains above government bond yields for nearly every country in the G-7,” Bullard continued.
Secondly, Bullard explained, “core and headline personal consumption expenditures (PCE) inflation measures continue to run some 40 to 60 basis points, respectively, below the FOMC’s 2% inflation target. Market-based measures of inflation expectations continue to
indicate expected longer-term inflation rates substantially below the Committee’s target. This is occurring despite the 25 basis point cut in July and the 25 basis point cut that was expected for the September meeting.”
“While the unemployment rate is low by historical standards, there is little evidence that low unemployment poses a significant inflation risk in the current environment,” he went on, adding that a larger rate reduction was needed to “provide insurance against further declines in expected inflation and a slowing economy subject to elevated downside risks.”
Bullard said it would be “prudent risk management … to cut the policy rate aggressively now and then later increase it should the downside risks not materialize….”
Elaborating on his reasons for advocating a 50 basis point cut in response to questions Monday, he said “one of the issues is I want to put the policy rate where it needs to be right now and let the data going forward tell us what to do… I prefer to get wherewe need to be… The yield curve tells us we need to be lower to get an upwardly sloping yield curve.”
Regarding his pessimistic outlook, in his prepared remarks, Bullard said “It is possible that a sharper-than-expected slowdown could materialize in the quarters ahead.” He listed the downside risks as:
*”the effects of magnified global trade policy uncertainty;
* “slowing growth in the global economy;
* “Contraction in global and U.S. manufacturing;
* “slowing U.S. business investment,” and
* “an inverted yield curve, which seems to suggest U.S. monetary policy may be too restrictive for the current environment.”
Bullard seemed particularly concerned about trade frictions, warning, “This is likely chilling global investment and feeding into slower global growth.”
While “the direct effects of trade restrictions on the U.S. economy are relatively small,” he said, “the effects through global financial markets may be larger.”
Bullard said “trade regime uncertainty” is “high” and is “being judgmentally factored into my monetary policy calculus” because its weakening effect on the global economy could feed back into the U.S. economy.
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The constantly shifting trade wars make it very difficult for the Fed to conduct monetary policy, according to Bullard: “The Fed cannot react to day-to-day changes in trade policy…It’s just not possible for monetary policy to react in a tit-for-tat manner to trade moves.”
Bullard put considerable emphasis on the undershooting of inflation, saying it gives the Fed “room to maneuver … We have some room where we can try to push inflation up to the pre-announced target. Our recent moves might help us get there.”
Although the FOMC has only cut the federal funds rate by 50 basis points, Bullard maintained that the shift in monetary policy early this year has contributed to a 129 basis point drop in two-year Treasury note yields. And he noted much of this drop fed through to mortgage rates.
Bullard said the FOMC’s divided decision last Wednesday reflected “a particular uncertainty now about how to read the macroeconomic tea leaves.”
Bullard told reporters he would like to see another 25 basis points of easing, but did not project beyond that. He likened the current Fed easing, which he has described as “insurance” and while Chairman Jerome Powell has described as a “mid-cycle adjustment” to the rate cuts made in the late 1990s during the Asian financial crisis, which he recalled the Fed was able to “take back” when that crisis did not have the feared reverberations on the U.S. economy.
Today, he observed, the Fed is taking out insurance against possible adverse effects of the trade war, but once again, the Fed could “take back” its cuts.
Bullard seemed to take small comfort from the rebound in the 10-year Treasury note yield and, hence, the the yield curve becoming less inverted. “It’s true yields have come back up in the last couple weeks from August lows,” he said, adding, “that’s not that surprising. Some of that sell-off during August was possibly overdone…Now we’re back in the 170 basis point region for the 2-year and 10-year..”
“Maybe that’s appropriate pricing,” he continued, “but it’s still down a good bit form last year” and “requires The Fed to…get to a lower place on the policy rate.’
Bullard was skeptical that recent liquidity shortages in the money market reflect a lack of reserves calling for a resumption of quantitative easing. Rather, he said, the New York Fed should make permanent the reverse repurchase (repo) facility it has used in recent days to inject liquidity. He said this is needed to complement the existing overnight reverse repurchase agreement facility.
“You would not have to use it most of the time,” he predicted. “It’s mere existence would stabilize trading.”