Brainard’s Argument for No September Hike Likely to Sway Fed

Kaptstream's Goldman: Chances of September Hike Are Low
  • Fed governor spells out risk-management calculus for prudence
  • Brainard comment is last word before FOMC meeting next week

Federal Reserve Governor Lael Brainard has just released a post-crisis monetary policy manifesto aimed at defusing any urgency to raise interest rates. For this month at least, the Federal Open Market Committee might agree.

Since June, the debate between camps on the FOMC has sharpened. On the one hand, there’s a majority group who want to move up rates gradually, based on their forecast of rising inflation and diminishing labor market slack. Positioned against that camp is a group of “other participants,” according to minutes of the Fed’s meeting in July, who see little evidence that inflation was responding to a tighter job market.

Brainard, in a speech Monday in Chicago, says this means there’s no reason to rush to raise rates because right now there seems little need to lean against an overshoot of inflation or employment. It’s an argument that will probably be persuasive when the FOMC meets on Sept. 20-21. Her remarks are the last ones in public from a Fed official before the central bank enters its pre-meeting quiet period.

“They all worry that if they go too quickly they could disrupt the economy and disrupt financial markets,” said Torsten Slok, chief international economist at Deutsche Bank AG in New York. “There is no reason to expect them to hike rates in September.”

Shrinking Slack

That doesn’t mean Brainard has won over the entire committee. Other officials are confident in their forecast that gradually diminishing economic slack will lift inflation over time. Under that scenario, the federal funds rate moves up gradually. That is the reason why the June Summary of Economic Projections had two rate hikes in the median outlook for 2016, even though core inflation was expected to finish the year at 1.7 percent.

Fed Chair Janet Yellen said last month that the case for a rate hike “has strengthened,” and Vice Chairman Stanley Fischer said that prices are “within hailing distance” of the Fed’s target. In effect, both suggest the time for a rate hike is near.

So why not move now?

While the committee will have a serious discussion about tightening, risk-management concerns will still win, said Michael Hanson, senior global economist at Bank of America in New York.

Asymmetric Risk

“This speech was more for her fellow committee members than it was for the markets,” Hanson said following Brainard’s remarks.

Part of Brainard’s argument is that the risks of running the economy a bit hotter are lower than the risks of raising rates too quickly, and getting the economy stuck in a slow-growth pattern with interest rates still near zero. In her own words, the “asymmetry in the conventional policy toolkit would lead me to expect policy to be tilted somewhat in favor of guarding against downside risks relative to preemptively raising rates to guard against upside risks.”

Her use of the word “preemptively” is a kind of attack against a piece of accepted wisdom that has governed Fed action in the past -- the notion dating from Alan Greenspan’s time as Fed chief that the central bank has to get ahead of overheating of either inflation or growth. In Brainard’s view, something fundamentally changed in the economy post-crisis to make that less worrisome.

Atlanta Fed President Dennis Lockhart put it another way to explain why the central bank wasn’t paying a high price for delaying action, telling reporters earlier on Monday that “I don’t feel we are incurring costs of patience that put a lot of urgency on the question of raising rates.”

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