Dudley Says Economic Outlook Little Changed Since Rate Riseby
Brushes off weak data and a drop in inflation expectations
Fed, markets diverge on trajectory for 2016 rate increases
The U.S. economy should continue to grow faster than its potential this year, supporting further interest-rate increases by the Federal Reserve, New York Fed President William C. Dudley said.
Dudley downplayed a recent string of weak economic data, prospects for “greater turbulence” in global financial markets driven by emerging-market weakness, and a drop in inflation expectations at a time price gains are lagging the central bank’s 2 percent objective.
The latest economic indicators need to be weighed against “strength evident in the U.S. labor market,” Dudley told the annual Economic Leadership Forum in Somerset, New Jersey. On net, for the economy,“the situation does not appear to have changed much” since the Fed’s Dec. 15-16 meeting, he said.
In December, Fed Chair Janet Yellen and her colleagues on the Federal Open Market Committee elected to raise the benchmark federal funds rate from near zero, where it had been held since December 2008. The median committee member projected the central bank would raise interest rates four times in 2016, according to materials released following the meeting, although many financial-market participants don’t see rates rising as much.
‘Convergence Over Time’
Dudley, the only regional Fed president with a permanent vote on the FOMC, said he wasn’t concerned by the differences between interest rates implied by futures markets and those contained in the central bank’s own outlook. “Projections will adjust as incoming information changes the economic outlook. I would expect convergence over time,” he said.
Dudley also downplayed recent weakness in measures of inflation expectations from consumer surveys. While the “most concerning” risk to the price outlook is the possibility that “inflation expectations become unanchored to the downside,” he said continued above-trend economic growth should push them higher.
“That said, should the economy unexpectedly weaken, then this fall in inflation expectations would become more concerning,” Dudley said. Answering a question from the audience after the speech, Dudley wouldn’t rule out considering negative rates if the economy were weak enough.
Global financial markets have been roiled in the month since the Fed raised rates, in part due to a depreciation in China’s currency and turbulence in that country’s shares, which have slid back into a bear market.
“Overseas developments, especially with respect to the emerging market economies, pose a risk to the U.S. economic outlook,” including potentially crimping demand for U.S. exports. Even so, “the most likely outlook seems to be more of what we have experienced in this expansion -- an economy that grows at slightly above a 2 percent annual rate this year.”
Still, the U.S. bond market’s “response to lift-off has been very mild,” Dudley said. “Generally so far, so good.” He did not comment on recent market volatility.
In the U.S., the benchmark Standard & Poor’s 500 stock index is down about 8 percent so far this year. It sustained another hit on Friday after a fresh round of weak data, including confirmation that U.S. retailers had their weakest year since 2009 and a decline in December factory output.
After it cut rates to zero in 2008, the Fed bought U.S. Treasuries and mortgage-backed securities to provide additional stimulus by pushing down long-term interest rates, amassing a $4.5 trillion balance sheet. It is currently reinvesting proceeds of maturing securities, and has said it will stop doing so and allow the balance sheet to shrink sometime after liftoff.
Dudley said the timing of that decision, as well as future interest rate decisions, would depend on economic data.
“If the economy were growing very quickly and the risks of an early return to the zero lower bound for the federal funds rate were deemed to be low, then I could see ending reinvestment at a relatively low federal funds rate,” he said. “In contrast, if the economy lacked forward momentum and the risks of a return to the zero lower bound were judged to be considerably higher, I would want to continue reinvestment until the federal funds rate was higher.”
Oil prices have fallen below $30 a barrel this week, down more than 50 percent since May, hammered by a global supply glut and faltering demand.
The decline in domestic investment in oil and gas drilling projects tied to the collapse in energy prices may continue, said Dudley. “I suspect that there remains a further leg down given the sector’s diminished cash flows and the reduced access to credit. In addition, manufacturing remains very soft,” he said, with the resurgent auto sector “close to a cyclical peak.”