It was more than a year ago when St. Louis Federal Reserve bank President James Bullard started raising the alarm about a U.S. bond market where interest rates seemed to show investors losing faith in the economy, a risky environment for the Fed to carry out planned rate increases.
As 2020 gets under way, the closely watched spreads between long- and short-term Treasury securities still don’t look completely healthy.
But with months of market turbulence and three rate cuts now in the rear view mirror, Bullard says he is ready to stand down, leave policy on hold for up to a year, and see what transpires.
“We eased substantially in 2019. That will come on board in 2020,” just as the United States and China also signal an easing of trade tensions with the Wednesday signing of a preliminary agreement, Bullard said in a Reuters interview. “We will see how much impact we have in the first half of 2020 and probably all the way through 2020, and then we will see where we are.”
That’s a shift for Bullard from what had been aggressive stumping, beginning as far back as late 2017, for the Fed to beware of raising interest rates too much, in part because of the behavior of the bond market.
But it is also further indication of a broader consensus that may well keep the Fed on the sidelines, with interest rates unchanged, throughout a potentially turbulent U.S. presidential election season.
The last year was a rocky one for the Fed, with markets upended by a global trade war, the central bank the target of verbal attacks by President Donald Trump, and policymakers divided on what the economy needed. Over the year there were dissents against the Fed’s quarter-point rate cuts coming from those who believed policy should be even easier and those who thought the opposite.
Bullard dissented twice in favor of deeper and faster cuts.
As the year ended, Fed officials across the spectrum agreed they could pause any further rate moves until something in the economy changes.
For those like Bullard who might have wanted even lower rates, it’s an acknowledgement the economy is still absorbing the massive shift toward looser monetary policy that the Fed engineered last year when it lowered the overnight policy rate to its current range of between 1.5% and 1.75%. For those who might have once been concerned about inflation or financial risks it’s an acknowledgement that as of now there’s little evidence of either.
NOT THE SAME OLD SONG
If 2019 had a theme, Bullard said, it was of the Fed fully coming to terms with the fact that low unemployment, low inflation, low interest rates, and a seemingly stable financial system can coexist. In standard theory they often conflict, with low unemployment sparking higher inflation. At this point, even the committee’s most ardent inflation “hawks” see last year’s rate cuts as a potential adjustment to that new world - a “reset,” as Kansas City Fed President Esther George called it Tuesday. She dissented against all three rate cuts last year on the view rates were low enough.
Neither Bullard nor George vote on policy this year.
“It was a year where we really came to grips with the idea that we were not going to go to 1990s or 2000 level interest rates in the United States,” Bullard said. “Not only did we quit trying...but we turned around and went the other way.”
It has been a longstanding debate, but since last fall policymakers have marked down their estimates of the underlying long-run “neutral” rate of interest to around half a percentage point, once accounting for inflation. Bullard thinks it is more like zero, but the point is made: the world’s different than when inflation-adjusted rates of 2% to 3% were the norm.
So is the United States in the clear?
Bullard says he now thinks 2020 could hold positive surprises as businesses finish readjusting to a less predictable trade environment, and start rolling out new strategies, methods and supply chains to cope. A tight labor market, he feels, could prompt capital investment that improves productivity.
And if trade uncertainty lifts, the United States “might grow faster than 2019, and it is that kind of dynamic that would lead us back to a better expected inflation environment,” that meets or exceeds the Fed’s 2% inflation target.
He hasn’t turned his back on the yield curve. The roughly quarter percentage point spread between 10- and 2-year Treasuries is well below what it was in the 1990s, say, during another extended era of growth. Bullard said he’d rest easier if it climbed to at least half a percent, signaling stronger market faith in growth and inflation.
But that’s no reason to argue for more rate cuts now, he said.
“We are going in the right direction.”
This article was originally published on Reuters.
