FRBNY President Bill Dudley gave a speech on Monday titled, “The 2015 Economic Outlook and the Implications for Monetary Policy.” His views matter because he is on the FOMC and reflects the views of the dovish majority of the committee. He and Fed Chair Janet Yellen tend to have nearly identical views. Here are a few highlights of his speech:
(1) In general, he paints a reasonably positive picture of the economy and says, “if my own forecast is realized, I would expect to favor raising the FOMC’s federal funds rate target sometime in 2015.”
(2) He says that several of the “headwinds” restraining US economic activity in recent years have subsided. The housing industry is in better shape. So are consumers. There is much less fiscal drag. Financial conditions are good: “Equity prices are high, borrowing costs are low, cash flows are strong and corporate balance sheets are healthy.”
(3) Lower energy costs should “lead to a significant rise in real income growth for households and should be a strong spur to consumer spending.” He adds that in the aggregate, “the swing from oil producers to consumers is quite large. For example, a $20 per barrel decline in global oil prices results in an income transfer of about $670 billion per year from producers to consumers.”
(4) On the other hand, he doesn’t expect a boom. He doesn’t see much upside from the current levels of housing starts and auto sales. The global economic slowdown and stronger dollar could weigh on US exports.
(5) Despite the drop in oil prices and the strength of the dollar, he expects that the core PCED inflation rate will move back towards the Fed’s target of 2% next year as resource utilization tightens.
(6) He agrees with market expectations that the Fed will start raising the federal funds rate around mid-2015. However, he is also willing to be patient:
(1) In general, he paints a reasonably positive picture of the economy and says, “if my own forecast is realized, I would expect to favor raising the FOMC’s federal funds rate target sometime in 2015.”
(2) He says that several of the “headwinds” restraining US economic activity in recent years have subsided. The housing industry is in better shape. So are consumers. There is much less fiscal drag. Financial conditions are good: “Equity prices are high, borrowing costs are low, cash flows are strong and corporate balance sheets are healthy.”
(3) Lower energy costs should “lead to a significant rise in real income growth for households and should be a strong spur to consumer spending.” He adds that in the aggregate, “the swing from oil producers to consumers is quite large. For example, a $20 per barrel decline in global oil prices results in an income transfer of about $670 billion per year from producers to consumers.”
(4) On the other hand, he doesn’t expect a boom. He doesn’t see much upside from the current levels of housing starts and auto sales. The global economic slowdown and stronger dollar could weigh on US exports.
(5) Despite the drop in oil prices and the strength of the dollar, he expects that the core PCED inflation rate will move back towards the Fed’s target of 2% next year as resource utilization tightens.
(6) He agrees with market expectations that the Fed will start raising the federal funds rate around mid-2015. However, he is also willing to be patient:
Finally, given the still high level of long-term unemployment and the outlook for inflation, there could be a significant benefit to allowing the economy to run "slightly hot" for a while in order to get those that have been unemployed for a long time working again.
(7) The pace of tightening will depend on the response of the financial markets:
If the reaction is relatively large--think of the response of financial market conditions during the so-called "taper tantrum" during the spring and summer of 2013--then this would likely prompt a slower and more cautious approach. In contrast, if the reaction were relatively small or even in the wrong direction, with financial market conditions easing--think of the response of long-term bond yields and the equity market as the asset purchase program was gradually phased out over the past year--then this would imply a more aggressive approach.
(8) Though all this implies that Fed policy is market dependent, Dudley then denied that the markets’ reactions matter:
Let me be clear, there is no Fed equity market put. To put it another way, we do not care about the level of equity prices, or bond yields or credit spreads per se. Instead, we focus on how financial market conditions influence the transmission of monetary policy to the real economy. At times, a large decline in equity prices will not be problematic for achieving our goals. For example, economic conditions may warrant a tightening of financial market conditions. If this happens mainly via the channel of equity price weakness--that is not a problem, as it does not conflict with our objectives.
Sorry, he lost me there.
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