Dudley Sees High Threshold for Change in Pace of Tapering

William Dudley, president of the Federal Reserve Bank of New York, said that while harsh weather will slow growth during the first quarter, it won’t harm the economy enough to merit slowing the tapering of bond purchases.

The winter weather doesn’t prompt “a fundamental change in the outlook,” and “does not rise to the level where you change the taper path,” Dudley said at an event in New York today organized by the Wall Street Journal. “The threshold is pretty high to change it.”

Policy makers are trying to determine whether recent economic weakness stems from harsh weather or fundamental obstacles to growth. At a March 18-19 meeting they’ll weigh whether to proceed with another $10 billion cut to their bond purchases, which would reduce the monthly pace to $55 billion.

“The economy should do better in 2014 than 2013,” Dudley said, predicting growth of about 3 percent. “The area of question” is the weather, which has been making analyzing economic data “more difficult” and will “depress economic activity” during the beginning of the year.

Dudley, who is also vice chairman of the policy-setting Federal Open Market Committee, said the weather would shave 0.5 percentage point to 1 percentage point off of the annualized growth rate during the first quarter.

“As we get into the spring, we’ll see some of these weather effects dissipate,” he said.

Harsh Winter

Philadelphia Fed President Charles Plosser predicted the U.S. economy will expand 3 percent this year even after the harsh winter.

“I believe that weakness largely reflects the severe winter weather rather than a frozen recovery,” Plosser said today in a speech in London. “So, we must be wary of attaching too much significance to the latest numbers.”

Stocks rose, extending a record in the Standard & Poor’s 500 Index, while Treasuries fell after fewer Americans filed claims for jobless benefits and the European Central Bank left interest rates at a record low. The S&P 500 climbed 0.3 percent to 1,879.29 at 1:27 p.m. in New York. The yield on the 10-year Treasury note climbed two basis points, or 0.02 percentage point, to 2.72 percent.

The Fed said yesterday the economy in most regions grew last month even as severe weather impeded hiring, disrupted supply chains and kept customers away from stores and auto dealerships. Eight of the central bank’s 12 districts “reported improved levels of activity, but in most cases the increases were characterized as modest to moderate,” the Fed said in its Beige Book business survey.

First Meeting

The Beige Book will be among reports reviewed by the FOMC this month during its first meeting led by Fed Chair Janet Yellen since she succeeded Ben S. Bernanke in February.

“Unseasonably cold weather has played some role,” Yellen said in reply to a question during Feb. 27 testimony to a Senate committee. “What we need to do, and will be doing in the weeks ahead, is to try to get a firmer handle on exactly how much of that set of soft data can be explained by weather and what portion, if any, is due to softer outlook.”

The Labor Department reported weaker-than-expected payroll growth in December and January and will probably report tomorrow that the economy added 149,000 jobs last month, according to the median estimate in a Bloomberg survey of economists. A private report on payrolls showed yesterday that companies in February added fewer workers than projected.

Raising Rates

The Fed should move away from its pledge to consider raising interest rates when unemployment falls below 6.5 percent given it’s “already a little bit obsolete,” Dudley said. Joblessness fell to 6.6 percent in January.

Dudley said he prefers a “qualitative” approach to guidance about the path of interest rates.

“We’re going to have to look at a broad set of labor-market conditions rather than one single indicator,” Dudley said.

The Fed should talk more about what happens after the first interest-rate increase, not just the timing of “liftoff,” Dudley said. Increases in borrowing costs will be “relatively gradual” because of the “persistent headwinds” to U.S. economic growth, he said.

The New York Fed chief said the central bank is “very watchful” to see if its unprecedented stimulus is fueling financial imbalances.

‘Financial Stability’

“When you look at the U.S. today, I don’t really see much excess in terms of things that worry me about financial stability,” Dudley said. Still, there are some areas that may be overvalued, such as biotechnology stocks, leveraged loans and farmland, he said.

“At this point, there’s nothing that’s substantive enough to cause me great concern,” Dudley said.

The Fed has the tools to “operate monetary policy with a very large balance sheet indefinitely,” Dudley said. The ability to pay interest on the cash banks park at the Fed will allow policy makers to keep inflation under control, he said. The Fed pays a deposit rate of 0.25 percent.

The Fed is also testing its new reverse repurchase agreement facility, and the results will inform policy makers about how the new tool may help create a floor for lending rates, he said.

The Fed has kept its target for the benchmark federal funds rate at zero to 0.25 percent since December 2008. It can be hard to “hit a precise number” with the fed funds rate, Dudley said.

The federal funds effective rate -- the average daily market rate on overnight loans between banks -- was 0.08 percent on March 5 and has traded below the interest rate on reserves for more four years.

Government Control

That distortion arises in part because Fannie Mae and Freddie Mac, the mortgage-finance companies under government control, became “significant sellers” of funds in the overnight market and aren’t eligible to place cash on deposit at the Fed, according to a December 2009 research paper by the New York district bank.

Fannie Mae and Freddie Mac are eligible to use the Fed’s repo facility, potentially allowing them to lend the central bank unlimited amounts of cash overnight at a fixed rate in exchange for borrowing Treasuries in so-called reverse repo transactions. Banks, broker-dealers and money-market funds are also able to use the facility.

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