Fed Officials See Interest-Rate Increase on Track for 2015

When Will Monetary Policy Distortion End?
  • Dudley says Fed tightening to be gradual following liftoff
  • Williams sees signs of asset price imbalances emerging

The Federal Reserve will probably raise interest rates later this year and tighten policy gradually thereafter, New York Fed President William C. Dudley said, echoing the sentiment of Chair Janet Yellen that an uncertain global outlook won’t postpone liftoff into 2016.

“The economy is doing pretty well,” Dudley said Monday at an event hosted by the Wall Street Journal in New York. “My expectation is that we probably will raise interest rates later this year.” Dudley said he expected growth in the second half will be a little bit weaker than in the first half, when the U.S. grew around 2.25 percent on an annualized basis.

San Francisco Fed President John Williams, speaking later on Monday, made a similar argument. Their remarks line up with Yellen, who said Sept. 24 she felt it likely the Fed would increase rates this year for the first time in almost a decade. The policy-setting Federal Open Market Committee decided Sept. 17 to hold rates near zero, citing worries over the slowdown in China that could damp U.S. growth and inflation. 

“Barring any significant change in the outlook, the Fed is telling us they plan to hike rates later this year,” Bricklin Dwyer, economist with BNP Paribas in New York, wrote in a note to clients.

Dudley, who cautioned in late August that the uncertain global outlook made the case for a rate increase in September less compelling, said his expectation on the timing of liftoff was “not calendar guidance. It depends on the data. That’s based on my view of how the economy is likely to evolve.” That includes developments abroad, particularly in China, where slowing growth has sapped commodity prices, which is helping to suppress U.S. inflation.

2015 vs 2016

Concern over the outlook for the world’s second-largest economy have roiled financial markets since China’s surprise currency devaluation on Aug. 11. Investors have reduced their bets the Fed would act at one of its two remaining FOMC meetings this year and saw a 40 percent probability of a move by the Dec. 15-16 FOMC, down from 49 percent on Sept. 21.

The Fed has held rates near zero since late 2008 to boost the economy through the worst recession since the Great Depression. Yellen last week discussed allowing U.S. unemployment to fall under the level that Fed officials estimate to be full employment to draw more workers back into full-time employment.

She also emphasized the Fed would tighten gradually once it had begun to raise rates, and Dudley repeated that assurance.

Gradual Pace

“We are going to go quite slowly,” he said, citing forecasts submitted by policy makers for the Sept. 16-17 FOMC. These had a median projection for the benchmark federal funds rate of 1.4 percent at the end of 2016, rising to 2.6 percent at the close of the following year.

“The reason we are going to go quite slowly, we think, is because the economy is not really that strong and monetary policy probably isn’t quite as easy as people think it is, just judging by the level of short-term interest rates,” Dudley said.

Unemployment in the U.S. has fallen to its lowest level in more than seven years, making it harder for the Fed to justify interest rates near zero. Inflation, however, has remained well below the Fed’s 2 percent target. It was 0.3 percent in the 12 months through August, as measured by the Fed’s preferred gauge of price pressures.

Williams, who repeated his view that the decision at the September FOMC to keep rates on hold was a “close call,” cautioned that he was beginning to detect risks of market imbalances, noting that house prices were rising rapidly, though they had not yet reached “tipping point.”

“I am starting to see signs of imbalances emerge in the form of high asset prices, especially in real estate, and that trips the alert system,” he said in a speech in Los Angeles. ”One lesson I have taken from past episodes is that, once the imbalances have grown large, the options to deal with them are limited.”

A third policy maker, Chicago Fed President Charles Evans, argued for more patience, saying the Fed should delay liftoff until next year to make sure inflation is definitely heading back up to the Fed’s 2 goal. Yet he also said the Fed was getting ready to act.

"We’re getting a lot closer to liftoff. Even in my own projections, where I have mid-2016, we are getting closer,” he told reporters after delivering a speech in Milwaukee. “We’ve made a lot of improvement on the labor market.”

Williams and Evans are both voting members of the FOMC this year.

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