Rosengren : Tight Labor Markets Justify Fed Plans to Keep Raising Rates -- 2nd Update
By Nick Timiraos
BOSTON -- Eric Rosengren, president of the Federal Reserve Bank of Boston, said increasingly tight labor markets should keep the U.S. central bank on its path to gradually raise rates and start slowly shrinking its portfolio of bonds and other assets, despite a surprising pause in inflation pressures this spring.
In an interview, Mr. Rosengren said he sees "some reasonable risk" that the unemployment rate drops below 4% in the next two years. "In my own view, that would not be sustainable," he said.
While the Federal Reserve's preferred inflation gauge has shown price pressures have eased since March, Mr. Rosengren said he was more focused on longer-run trends in labor markets, which argue for continued rate increases, than on month-to-month inflation figures.
Fed officials have strongly suggested their next step -- before another rate increase -- will be to announce in September they will begin winding down their holdings of Treasury and mortgage securities. Mr. Rosengren appeared to support that view.
"I do think the market has appropriately started to say, 'Gee, this seems to be about the right time'" to announce the wind-down of the balance sheet, said Mr. Rosengren, who isn't a voting member of the Fed's rate-setting committee this year. With the Fed's benchmark short-term interest rate well away from near zero, "there's no reason to have that extraordinary accommodation coming from the balance sheet any longer," he said.
Officials believe that as the jobless rate falls, pressures are building on firms to raise wages and economic resources more broadly are becoming scarcer, which will move inflation higher.
Several measures of wages and salaries show that over the last two years, "the trend is very clearly going up, which is an indication that we're probably a little past full employment," Mr. Rosengren said. "And to be honest, it's a little early to be seeing that" because the unemployment rate only recently fell below the level officials believe will generate inflation.
The Fed voted last week to keep its benchmark federal-funds rate steady in a range between 1% and 1.25% and indicated that at its next meeting it could announce it will begin allowing small amounts of the $4.2 trillion in Treasury and mortgage securities it amassed after the financial crisis to roll off its balance sheet.
The Fed's next meeting is Sept. 19-20. In June, officials raised rates for the second time this year and penciled in one more quarter-point increase this year. Mr. Rosengren said he still expects the Fed will need to raise rates one more time this year.
Mr. Rosengren was a staunch advocate for the Fed's campaign to provide generous stimulus after the financial crisis, but over the past year he has advocated for the Fed to steadily unwind that support to avoid an economy that overheats.
The central banker said employers across New England have voiced growing concerns about the difficulty in finding workers, which he said should eventually lead to higher wages. For employers, "that takes some time. You wait to see if you can fill the jobs" at higher wages, he said. "And when you increase the wages you know there's going to be pressure to give wage increases to everyone else on your staff that are in a similar position."
Employers can be reluctant to pay more "until it's clear that you actually have to do it," Mr. Rosengren said. "I think we're getting to the point in many places...where they're saying, 'It's going to cost me too much money not to hire the extra labor. It's worth paying those higher wages.'"
Fed Chairwoman Janet Yellen has said recent weakness in inflation readings should prove largely transitory because they resulted from idiosyncratic declines in the prices of a few items, such as wireless phone plans, and because labor markets have tightened.
The Fed's preferred inflation gauge, excluding the volatile food and energy sectors, rose 1.5% in June from a year earlier, roughly in line with the annual pace recorded in May, the Commerce Department said Tuesday. That is down from 1.9% in February.
Some officials have said the central bank should pause rate increases until they see stronger evidence inflation pressures have picked up, though they haven't expressed similar qualms about proceeding with plans to slowly shrink the bond portfolio. As a result, the Fed now looks poised to announce the implementation of the balance-sheet strategy in September before raising rates again in December.
The Fed bought more than $4 trillion in Treasury and mortgage securities during and after the financial crisis to stimulate the economy by holding down long-term rates. Allowing the balance sheet to decline could cause long-term rates to rise.
The Fed stopped adding to its balance sheet in late 2014, but the central bank has been reinvesting the proceeds of maturing assets to keep the holdings steady. Officials have said they want the plan to run quietly in the background once it starts.
One potential complication would be a congressional standoff over raising the Treasury's borrowing limit. The Treasury Department has employed emergency cash-conservation steps that Secretary Steven Mnuchin said should last through September. After that, the U.S. risks being unable to make timely payments on government bills if Congress hasn't raised the debt ceiling, and the threat of default could roil financial markets.
Mr. Rosengren said the Fed should be mindful of any potential financial turbulence when it announces any balance-sheet plan. "It makes sense to have some flexibility depending on what national and international conditions are at the time that we make the announcement," he said.
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