Williams Sees Gradual Rate Rises as Economy Faces Headwinds

  • San Francisco Fed President says domestic U.S. economy strong
  • Market swings shouldn't be seen as beginning of `apocalypse'

Federal Reserve Bank of San Francisco President John Williams said his outlook for growth in the U.S. and the rest of the world hasn’t changed despite the latest financial-markets upheaval, and repeated that he expects the Fed to gradually normalize policy.

“Short-term fluctuations or even daily dives aren’t accurate reflections of the state of the vast, intricate, multi-layered U.S. economy. And they shouldn’t be viewed as the four horsemen of the apocalypse,” Williams said in the text of his speech at a Town Hall Los Angeles event on Thursday. “What’s important is how it impacts jobs and inflation in the U.S.”

Policy makers including Fed Chair Janet Yellen have signaled that they need more information to assess whether weaker growth in countries such as China and a rout in financial markets will ripple through the U.S. economy. Investors are predicting no interest-rate increases this year based on prices of fed funds futures contracts. The Fed raised borrowing costs in December for the first time in almost a decade and projected that it would tighten policy by 1 percentage point in 2016.

Williams said the U.S. has reached or is close to maximum employment and predicted that the jobless rate would edge toward 4.5 percent later this year, compared with 4.9 percent in January. The labor-force participation rate appears to be in line with its longer-term trend and more people are quitting their jobs in confidence they’ll find another, underscoring strength in the labor market, he said.

Inflation Goal

The Fed is on course to reach its 2 percent inflation goal over the next two years, Williams said.

“Current U.S. inflation pressures are playing tug-of-war,” he said. “On one side, falling prices for energy and most goods are pulling us down, reflecting the strong U.S. dollar and other international developments. On the other, rising prices for domestic services are mostly trying to yank us to the 2 percent line.”

Responding to questions after the speech, Williams said there’s no real reason to worry about the state of the U.S. economy and didn’t see risks of a recession. “The economy is actually doing fine,” said Williams. “Inflation is a little low but it’s because of these global factors.”

A steep increase in rents reflects the nation’s economic strength, and wage growth is also showing signs of a pick-up, he said, highlighting the boost household incomes will experience as a result, which could underpin consumption spending.

“If we look at the domestic market in isolation, it shows strong growth. We’re just contending with outside forces,” Williams said. 

Minutes of the January Federal Open Market Committee meeting released Wednesday showed that policy makers were concerned that a sharper deceleration in Chinese growth could increase financial stress in emerging markets and, importantly, in the economies of big U.S. trading partners such as Mexico and Canada. They were also unsettled about the economic impact of further persistent declines in stocks as well as widening credit spreads.

Keen Eye

“We are closely watching situations abroad. But not because we should act in response to, say, financial volatility in China,” Williams said. “Yes, global markets affect U.S. growth; but we are also powered by domestic demand and have the ability to make our own monetary policy.”

Fed officials will hold their next meeting on March 15-16, when they are set to submit fresh quarterly forecasts for the U.S. economy and their estimates of the appropriate pace of rate increases over coming years.

Williams said he continues to see a gradual pace of policy normalization as being the best course. He declined to comment on his specific interest rate forecast.

“My preferred route is a gradual path of increases,” he said. “This reflects the fact that the economy still needs a gentle shove forward from monetary policy, as we continue to navigate the headwinds from weakness abroad and their effects on the dollar and commodity prices.”

While the Fed has tools to deal with an economic downturn including negative interest rates, Williams said he didn’t expect that it will have to use them.

“We have options if things got worse, much worse, significantly worse,” he said. “I see negative interest rates as being a tool that’s a possibility that you could consider. I don’t see it at all likely given where things are.”

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