Fed's Dudley Touts Gradual Rate Rises -- Update

Federal Reserve Bank of New York President William Dudley shrugged off weak inflation data in a speech Thursday and called for more rate rises, citing ongoing economic strength and the failure thus far of financial markets to translate central bank rate rises into tighter real world financial conditions.

Given the economy's current outlook, "I expect that we will continue to gradually remove monetary policy accommodation," Mr. Dudley said in the text of a speech prepared for delivery before a gathering of Money Marketeer of New York University. The path of those increases is likely to be "shallow," he said.

The veteran central banker didn't say when he would like to see the Fed boost what is now a 1% and 1.25% overnight target rate range.

But he nevertheless affirmed he supported boosting the cost of borrowing, even as many of his colleagues are questioning that path. This year has brought unexpectedly weak inflation data that once again shows the central bank falling well short of achieving its 2% inflation rise goal.

"Even though inflation is currently somewhat below our longer-run objective, I judge that it is still appropriate" to press forward with a slow and steady path of rate rises, Mr. Dudley said. "This judgment is supported by the fact that financial conditions have eased, rather than tightened" even as the Fed has boosted short-term rates three quarters of a percentage point since the end of 2016.

Mr. Dudley, who also serves as vice chairman of the interest-rate-setting Federal Open Market Committee, has long argued financial conditions are a critical part of the overall monetary policy equation. If Fed rate rises aren't reflected in a generalized tightening in financial conditions, it can argue for central bankers to be more aggressive than they would otherwise be. And thus far, Mr. Dudley appears to believe markets aren't working in tandem with the Fed.

"Equity prices have risen, credit spreads have narrowed modestly, longer-term interest rates have declined, and the dollar has weakened," Mr. Dudley noted. "On balance, these movements have been large relative to the upward drift in short-term interest rates."

Mr. Dudley's appetite for rate rises runs up against other central bankers who are questioning the need for rate increases. A number of regional Fed leaders, as well as some governors, have said they need to regain confidence inflation will rise before endorsing another rate increase. The Fed's June outlook showed officials predicting another rate rise before the end of the year. And while most economists still see an increase happening in December, financial markets aren't .

"We should be cautious about tightening policy further until we are confident inflation is on track to achieve our target," Fed governor Lael Brainard said in a speech in New York on Tuesday.

Mr. Dudley, however, isn't as concerned about inflation.

Higher import prices, in part tied to a weaker dollar, and the ebbing of one-off factors weighing on price rises "causes me to expect inflation will rise and stabilize around the FOMC's 2% objective over the medium term," Mr. Dudley said. He said that he has been surprised by the weakness of inflation and noted some of it may be related to structural changes in the economy.

Mr. Dudley was largely upbeat about the economy. "The fundamentals supporting continued expansion are generally quite favorable," he said, adding "I expect that the U.S. economy will continue to perform quite well, with slightly above-trend growth leading to further gradual tightening of the U.S. labor market." That should boost wages and in turn help push inflation higher, he said.

Mr. Dudley added the massive hurricane that struck Texas is unlikely to derail the economy's ongoing path of expansion.

While Mr. Dudley flagged an easing in financial conditions as a reason to boost rates even when inflation is short of the Fed's target, he isn't concerned markets are a bubble. "Asset valuations are not particularly troublesome given the economic environment in which we've been," he said.

The New York Fed leader said a looming cut in the size of the Fed's balance sheet should have at best a "modest" impact on financial conditions. Cutting holdings -- most expect to see the Fed start the process of reducing its $4.5 trillion in holdings at the coming September FOMC meeting -- is justified by the economy's health and a desire to reduce holdings in case more purchases are needed to deal with future economic weakness.

Mr. Dudley said holdings will likely be reduced to between $2.4 trillion and $3.5 trillion at some point in the early 2020s.

Write to Michael S. Derby at michael.derby@wsj.com

Federal Reserve Bank of New York President William Dudley said Thursday recent inflation weakness is unlikely to deter him from supporting more rate rises given that the economy remains robust and overall financial conditions are moving in the opposite direction of central bank policy aims.

The economy's current path indicates "we will continue to gradually remove monetary policy accommodation," Mr. Dudley told a gathering of Money Marketeers of New York University. He added the path of those increases is likely to be "shallow," suggesting modest increases.

The veteran central banker didn't say when he would like to see the Fed boost what is now a 1% and 1.25% overnight target rate range. The official cautioned in response to an audience question the outlook for rate rise won't be decided by any one factor.

Mr. Dudley's support of rate rises comes as many of his colleagues are questioning that path. This year has brought unexpectedly weak inflation data that once again shows the central bank falling well short of achieving its 2% inflation rise goal.

A number of regional Fed leaders, as well as some governors, have said they need to regain confidence inflation will rise before endorsing another rate increase. The Fed's June outlook showed officials predicting another rate rise before the end of the year. And while most economists still see an increase happening in December, financial markets participants don't.

"We should be cautious about tightening policy further until we are confident inflation is on track to achieve our target," Fed governor Lael Brainard said in a speech in New York on Tuesday.

Mr. Dudley is less worried about price pressures.

Meanwhile, higher import prices, in part tied to a weaker dollar, and the ebbing of one-off factors weighing on price rises, "causes me to expect inflation will rise and stabilize around the FOMC's 2% objective over the medium term," Mr. Dudley said. He said that he has been surprised by the weakness of inflation and noted some of it may be related to structural changes in the economy.

Mr. Dudley was largely upbeat about the economy, sayings its fundamentals "are generally quite favorable." He added, "I expect that the U.S. economy will continue to perform quite well, with slightly above-trend growth leading to further gradual tightening of the U.S. labor market." That should boost wages and in turn help push inflation higher, he said.

Mr. Dudley added the massive hurricane that struck Texas is unlikely to derail the economy's ongoing path of expansion. He also noted that the storm's aftermath could offer a modest boost to growth, and that it could add volatility to upcoming inflation data.

While Mr. Dudley flagged an easing in financial conditions as a reason to boost rates, he isn't concerned markets are a bubble. "Asset valuations are not particularly troublesome given the economic environment in which we've been," he said.

Mr. Dudley said holdings will likely be reduced to between $2.4 trillion and $3.5 trillion at some point in the early 2020s.

Write to Michael S. Derby at michael.derby@wsj.com

(END) Dow Jones Newswires

September 07, 2017 20:58 ET (00:58 GMT)