Kaplan, Dalio, Bullard Echo Call for Fed Pivot Toward Inflation
The Federal Reserve’s policy outlook needs to be more attuned to inflation risks, according to a number of influential voices who spoke Monday.
Dallas Fed President Robert Kaplan said he favors starting the process of tapering the central bank’s ongoing bond purchases “sooner rather than later,” while his counterpart from St. Louis, James Bullard called it “appropriate” that policy makers last week opened the taper debate.
“No one really knows how this is all going to unfold,” Bullard said during an event hosted by the Official Monetary and Financial Institutions Forum, where Kaplan also spoke. “We have to be ready for the idea that there is upside risk to inflation and for it to go higher.”
The yield on 10-year U.S. Treasuries rose along with stocks during the day.
“I think we’d be healthier, as we’re making progress in weathering the pandemic and achieving our goals, to start adjusting these purchases -- Treasuries and mortgage-backed securities -- sooner rather than later,” Kaplan said.
New York Fed President John Williams, however, expressed a more relaxed view on Monday, saying he continues to view the recent spike in inflation as a temporary phenomenon.
“I expect that as price reversals and short-run imbalances from the economy reopening play out, inflation will come down from around 3% this year to close to 2% next year, and in 2023,” Williams said in remarks prepared for a virtual speech.
Williams added that high levels of unemployment would also dampen the inflationary impulse. “I cannot stress enough that we still have a long way to go to get back to full strength” in the labor market, he said.
Williams, a permanent voter on the FOMC, is considered one of the most influential members of the panel behind Fed Chair Jerome Powell and Vice Chair Richard Clarida. Neither Bullard nor Kaplan are voters this year.
Powell will have an opportunity to add to the debate Tuesday afternoon during an appearance before a congressional panel.
Last week, following the June 16 meeting of the Federal Open Market Committee, Powell revealed that in coming meetings officials would discuss when and how to reduce their monthly purchases. New Fed interest-rate projections released the same day showed many policy makers brought forward their expectations for when they would move upward. The median projection pointed to two hikes in 2023.
That was met with approval by commentators who have been warning that the combination of government stimulus and the reopening of the economy as vaccinations control the Covid-19 pandemic might cause overheating and inflation that derails the economic recovery.
Speaking Monday at the Qatar Economic Forum, billionaire investor Ray Dalio said he expected the Fed could achieve its desired results with relatively modest actions.
“It’s easy to say that the Fed should tighten, and I think that they should,” said Dalio, the founder of Bridgewater Associates, the world’s biggest hedge fund. “But I think you’ll see a very sensitive market, and a very sensitive economy because the duration of assets has gone very, very long,” he said.
At the same event, former Treasury Secretary Lawrence Summers remained more strident.
“Much of the consensus of professional forecasters in February was that we would have inflation just above 2% this year,” said Summers, a paid contributor to Bloomberg News who served in previous Democratic administrations. “We’ve already had more inflation than that in the first five months of the year.”
That suggests “to me that people should not just modify their forecasts but should think about what their errors of thinking were that led them to be so far off in their forecasts,” he said.
The Fed’s hawkish pivot last week translated into swift action in the bond markets. The spread between 5- and 30-year Treasury rates flattened to levels not seen since September.
Meanwhile, measures of inflation expectations -- namely, the 5- and 10-year breakevens -- have slipped from where they were on Wednesday, suggesting greater confidence that the Fed will gain the upper hand on inflation.
Another Qatar forum speaker and former Treasury secretary, Steven Mnuchin, said he didn’t think investors were prepared for a scenario of tightening monetary policy.
“There’s no question the Fed needs to go into a period of normalizing rates and normalizing the portfolio” of bond holdings, said Mnuchin, who served under Republican President Donald Trump for four years. “I think this is something that needs to be watched very carefully and I do think the markets are underestimating this risk.”
Despite the movement in the so-called dot-plot of Fed rate projections and the views from Fed officials like Kaplan and Bullard, it remains somewhat unclear how much Powell’s views had changed on the policy path.
In his post-meeting press conference, the Fed chief played down the signal from the dot plot, urging it be taken with a “big grain of salt.” He also stuck by his view that the recent surge in prices was driven by transitory factors.
The Fed’s preferred gauge of inflation hit 3.6% in the year through April, and 3.1% when excluding the volatile components of food and energy.
Powell also emphasized that the only policy debate now on the table had to do with bond purchases, not rates.
“We did not actually have a discussion of whether liftoff is appropriate at any particular year because discussing liftoff now would be -- would be highly premature,” Powell said.
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