Fed's Kaplan: Can Be Patient on Next Rate Hike

--Looking for Progress on Inflation 

--Balance Sheet Run-Off Can Begin 'Soon'

--Neutral Rate Has Fallen; Closer to 2% Than 3% 

By Jean Yung

     WASHINGTON (MNI) - Federal Reserve Bank of Dallas President Robert Kaplan

said Thursday the Fed can afford to be patient in raising interest rates in the

face of weaker-than-expected inflation readings, though he supports starting to

cut the balance sheet soon. 

     "At this stage I'd like to see more progress, particularly in the Fed

reaching its inflation target, before I consider another rate increase," he told

the Lubbock Chamber of Commerce in Texas. Kaplan is a voter on the rate-setting

Federal Open Market Committee this year. 

     His comments come after the minutes of the last FOMC meeting revealed

Wednesday some other officials also argued against further rate hikes until new

data confirmed inflation was more clearly on a path toward the Fed's 2% target. 

     The FOMC had forecast one more hike for the year, but consumer inflation as

measured by the core personal consumption expenditures price index slowed in the

spring and rose just 1.5% from a year earlier in July. 

     Another reason to be patient on raising interest rates is the so-called

neutral rate, the setting for the fed funds rate that's neither accommodative

nor stimulative, has fallen from five to 10 years ago, Kaplan said. It's

currently "closer to 2% than to 3%," he said. 

     That also "tells me we have to be careful on our further moves on the fed

funds rate," he said.

     The Dallas Fed chief cited as a further reason for caution the risk that

the yield curve could flatten or become inverted, given the spread between the

2-year and 10-year Treasury yields is narrow at just 90 basis points. 

     An inverted or flat yield curve "historically has been a sign of economic

trouble," so minimizing that risk offers another reason "we should be very

patient and judicious on our next moves on the fed funds rate," Kaplan said. 

     The 10-year Treasury yield, at just 2.23%, signals expectations of economic

growth are sluggish, Kaplan said. He added he expects GDP to expand just over 2%

this year. 

     Some factors driving slow growth are an aging population and a slow growing

workforce, Kaplan said, issues that monetary policy cannot dress. The economy

could benefit from broader economic policies including regulatory review,

immigration, infrastructure spending and better skills training, he said. 

     The economy still has room to "grow jobs," Kaplan said, though that space

might be limited. The U-6 rate of unemployment, which includes discouraged

workers and those who want to work full time but are only working part time,

measures at 8.6% today, compared to 8.1% before the recession. 

     "We got some slack, but it's not as substantial as people think," Kaplan

said. 

     Like many of his FOMC colleagues, Kaplan said it would soon be time to

begin the process of ending reinvestments in order to shrink the Fed's balance

sheet. 

     "I think we should begin the process soon of letting our balance sheet

begin to run off," he said. 

     "We've designed this run-off in a way so it's very gradual," Kaplan said.

"We can actually do this run-off without having a material effect on the price

levels of these securities."

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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