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Fed’s Dudley Says U.S. Isn’t ‘Out of the Woods’: Economy

Federal Reserve Bank of New York President William C. Dudley
Federal Reserve Bank of New York President William C. Dudley. Photographer: Andrew Harrer/Bloomberg

Federal Reserve Bank of New York President William C. Dudley said signs the economy is improving don’t dispel risks to growth that include higher gasoline prices, fiscal cutbacks and a weak housing market.

“The incoming data on the U.S. economy has been a bit more upbeat of late, suggesting that the recovery may be getting better established,” Dudley said today in a speech in Melville, New York. “But, while these developments are certainly encouraging, it is far too soon to conclude that we are out of the woods in terms of generating a strong, sustainable recovery.”

Dudley’s comments elaborated on a March 13 statement by the Federal Open Market Committee, which noted that unemployment has declined while remaining “elevated.” Dudley, FOMC vice chairman, said the economy has shown signs of strength partly because of inventory building and unseasonably warm weather. Responding to an audience question, he said “nothing has been decided” about more bond-buying by the Fed to spur growth.

The New York Fed chief’s comments “reiterate a very dovish position among the leaders of the FOMC, those setting the policy agenda,” said Eric Green, chief economist at TD Securities Inc. in New York and a former economist at the New York Fed. The speech is “consistent with the FOMC statement last week, but must also be seen as being more dovish, couching progress on the economic front with uncertainty,” he said.

The FOMC last week upgraded its assessment of the economy while saying the benchmark interest rate was likely to stay close to zero through at least late 2014.

Weighing Stimulus

Policy makers are weighing whether the stimulus that helped fuel the best six-month streak of job growth since 2006 is sufficient for meeting the Fed’s goal of full employment. Joblessness has fallen to 8.3 percent, the lowest in three years.

“Real economic activity has yet to be strong enough on a sustained basis to make a big dent in the overall amount of slack in the U.S. economy,” Dudley, 59, said in his prepared remarks.

About half of the drop in the unemployment rate since September “was due to a declining labor force participation rate,” Dudley said. “Had the labor force participation rate not declined from around 66 percent in mid-2008 to under 64 percent in February, the unemployment rate would still be over 10 percent.”

The Standard & Poor’s 500 Index rose 0.4 percent to 1,410.36 at 12:16 p.m. in New York, while the yield on the 10-year Treasury note was at 2.31 percent.

Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd., said Dudley’s comments were too downbeat.

‘Pessimistic Forecast’

“The FOMC vice chairman seems overly committed to a pessimistic forecast,” Rupkey said. “Their dismal outlook for the economy may hurt the very recovery that their policy seeks to bolster.”

Stocks rallied last week and Treasuries tumbled as reports showing growth in manufacturing in the northeast and a drop in jobless claims bolstered confidence in the world’s largest economy. The S&P 500 advanced 2.4 percent in five days to 1,404.17 on March 16, the highest since May 2008.

Bonds of all types worldwide are generating their biggest losses since 2010 this month, raising concern that the four-year bull market that pushed interest rates to record lows may be ending as the Fed’s flood of liquidity begins to subside.

The drop has been led by U.S. Treasuries, which are down 1.5 percent, including a 5.9 percent plunge in the benchmark 30-year bond.

Inventory Contribution

Dudley downplayed some recent positive signals. The U.S. economy expanded at a 3 percent annual pace in the last three months of 2011, the fastest since the second quarter of 2010. Inventories accounted for 1.9 percentage points of growth during the fourth quarter.

“Historically, a quarter in which inventory investment makes a significant growth contribution is typically followed by a quarter in which that growth contribution is modest or even negative,” Dudley said. “That appears to be what is shaping up for the first quarter of this year.”

Dudley’s remarks to the Long Island Association, an organization of business groups, unions, nonprofits and government agencies representing Nassau and Suffolk counties, which have each declared fiscal emergencies, were his first public comments since the FOMC met on March 13.

Dudley also said that though the “unusually mild weather” recently in the U.S. has curbed demand for heating, it “temporarily boosts economic activity overall,” leading to “higher-than-normal levels of construction activity.”

‘A Little Brighter’

Dudley said in response to audience questions after his speech that interest rates have moved up in the market over the past week as parts of the economy look “a little brighter.” Credit availability is “still tight,” while improving gradually, he said.

The Fed’s outlook for low interest rates until late 2014 “is a forecast of what we currently anticipate we’re going to do,” and policy makers could decide to raise their benchmark rate earlier or later, depending on how the economy evolves, Dudley said.

Claims for jobless benefits dropped the week before last to match a four-year low, Labor Department figures showed March 15. Applications for unemployment insurance payments fell by 14,000 to 351,000 in the period ended March 10.

Inflation Concerns

Inflation concerns contributed to the rise in Treasury yields last week after a government report showed that consumer prices increased in February by the most in 10 months, with gasoline accounting for 80 percent of the gain.

The consumer-price index climbed 0.4 percent in February, after increasing 0.2 percent the prior month. The so-called core measure, which excludes more volatile food and energy costs, advanced 0.1 percent.

Consumer prices increased 2.9 percent in the 12 months ended in February, the same as in January. The Fed aims for an inflation rate of 2 percent.

Inflation will probably “moderate further” this year despite the increase in gasoline prices, Dudley said, adding that inflation expectations “remain well anchored.”

While core inflation “has been somewhat higher than expected a few months back, it appears that the annual rate of core inflation has peaked and we expect it to begin to decline later this year,” Dudley said.

Unemployment Outlook

Unemployment will “decline gradually” toward Fed’s goals, and the inflation outlook is “subdued,” the FOMC said in a statement after its March 13 meeting. Policy makers said they expect “moderate economic growth,” compared with a prediction of a “modest” expansion after their January meeting.

The Fed has kept its benchmark rate near zero since December 2008, and in January extended a previous pledge to keep rates low through mid-2013. It has bought $2.3 trillion of bonds in two rounds of so-called quantitative easing to hold down borrowing costs.

“We cannot lose sight of the fact that the economy still faces significant headwinds and there are some meaningful downside risks,” Dudley said.

“The risk of higher gasoline prices is a real one for the U.S. economy,” Dudley said in response to audience questions. Consumer spending is often hurt by higher commodity costs, he said. Dudley said he is “cautiously optimistic” about the outlook for the sovereign debt crisis in Europe, and that the risks of a municipal debt crisis in the U.S. are also receding.

Consumer Confidence

Confidence among U.S. consumers unexpectedly dropped in March as the jump in gasoline prices threatened to squeeze household budgets. The Thomson Reuters/University of Michigan preliminary index of consumer sentiment fell to 74.3, the lowest this year, from 75.3 the prior month.

Life Time Fitness Inc., which operates 95 fitness centers, is among companies expressing caution about the outlook for consumer demand. The company is seeing “pressure” in enrollment fees, Michael Robinson, chief financial officer of the Chanhassen, Minnesota-based company, said last week at UBS AG’s Global Consumer Conference.

“We made a decision back in early 2009 that we don’t expect a consumer to rebound back to the vibrant levels that we were seeing back in 2005 and 2006 and 2007,” Robinson said.

“There has been some improvement in the economy, but we still see a very discerning member or a very discerning customer trying to decide whether to be a member or not,” he said.

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