Mary Daly, president at the Federal Reserve Bank of San Francisco, stands for a photograph outside of her office in San Francisco, California, U.S. (Photographer: David Paul Morris/Bloomberg)

Fed's Daly Sees Possible December Rate Hike, Two 2019 Moves

(Bloomberg) -- Federal Reserve Bank of San Francisco President Mary Daly said U.S. policy makers ought to be gradually lifting interest rates to bring an economy that’s running above potential in for a soft landing.

Fed's Daly Sees Possible December Rate Hike, Two 2019 Moves

“It wouldn’t be surprising to me that we would need to go up again in December and at least a couple of times next year,” Daly told Bloomberg News Monday in her first interview on policy since she became head of the regional Fed branch on Oct. 1.

That would be enough to get to her estimate of neutral, or the level of interest rates that neither spurs nor slows the economy. “In my modal expectation, I think that’s something that will be needed.”

Daly later clarified in remarks to reporters following a speech in Idaho Falls, Idaho that she isn’t set on a December move in particular. She said two to three rate increases will be appropriate over the next “period of time,” but the timing remains to be seen. Daly voted for the first time at the Fed’s policy meeting in November and will vote again at the Dec. 18-19 gathering, at which officials are expected to hike for the fourth time this year.

“We have an economy that is running above potential, a labor market that’s hot, robust,” and “normalizing policy in a way that creates a soft landing, I think, is a challenging issue,” she said in the Bloomberg interview. “It’s a process of iterative learning.”

The Fed is raising rates at a time when the economy is looking strong and wage pressures are creeping up. Unemployment has fallen to 3.7 percent, its lowest level since the 1960s, and inflation is near the Fed’s 2 percent goal.

“I don’t feel worried about inflation, I’m actually relieved that it’s come back to target, and I’m feeling optimistic that it will remain at target,” said Daly, who served as San Francisco Fed research director when it was led by now-New York Fed President John Williams.

December Hike

The probability of a December rate increase is hovering around 75 percent, based on trading in federal funds futures, and most Fed officials have said they support further gradual rate increases. But 2019 could require policy makers to make tough calls: They expect to reach neutral rates at some point next year.

Some Fed officials say the central bank should survey the economic landscape when they reach that point, while others point to U.S.’s low unemployment rate and say rates may go higher to prevent the economy from running too hot. Policy makers’ economic projections show that the median official has penciled in a mild overshoot of neutral starting next year.

Daly said she’ll be watching how markets and the economy react to policy and will be keeping an eye out for shocks to the economy as she thinks about how central bankers should proceed once they hit the dividing line between easy and restrictive monetary policy.

“Where to go after that remains uncertain,” Daly said. She later told reporters that she sees the nominal neutral rate from 2.5 percent to 2.8 percent, which is slightly below the 3 percent median estimate in quarterly Fed forecasts updated in September.

Trade Uncertainty

Daly said she’s watching closely for any signs that uncertainty over trade policy is rattling businesses, and indicated she isn’t worried about recent stock market falls.

“There was a broad consensus across policy makers, but also market participants, that valuations were higher than could be supported,” she said in the Bloomberg interview. “So then a correction is something that I would view as a positive.”

She said from a policy maker’s perspective, it actually suggests that financial markets are "re-bridling themselves.”

“When you see these other factors emerge, that financial markets are readjusting” and banks are getting themselves in order to sustain slower growth, then “that means that there are self-bridling mechanisms in the economy that are going to be augmenting the interest rates increases that we have taken.”

©2018 Bloomberg L.P.