MNI ANALYSIS: Fed's Brainard Sees Gradual Hikes 'Appropriate'

--Policy Path Will Move To Neutral, After Some Time Likely To Move Past Neutral

--Yield Curve Inversion Could Happen, Likely A 'Less Adverse Signal'

--Mild, Temporary Overshoot In Inflation Could Push Underlying Inflation Up

--Forward-Guidance Language On Rates Lower Than Longer-Run "Stale" 

By Sara Haire

     WASHINGTON (MNI) - Gradual rate hikes remain "appropriate," Federal Reserve

Governor Lael Brainard repeated in her remarks delivered to the Forecasters Club

of New York on Thursday, one of the last public appearances by a Federal Reserve

official before the blackout period begins ahead of the June meeting.

     Despite the yield curve's potential for inverting, Brainard indicated that

the policy path should continue on its gradual path of removing accommodation. 

     "If the 10-year term premium were to stay very low, that path would likely

imply a yield curve inversion," Brainard said. She continued on to explain that

if the term premium does remain low, there would likely be a "less adverse

signal from any given yield curve spread."

     "With the term premium today very low by historical standards, this may

temper somewhat the conclusions that we can draw from a pattern that we have

seen historically in periods with a higher term premium," Brainard said. 

     The flattening of the yield curve, is "one among several important

indicators" Brainard looks at. Broader context of the financial conditions is

needed when interpreting the movements in the yield curve, she said.

     In contrast, St. Louis Fed Chief James Bullard reiterated in Tokyo, May 29

that the yield curve could invert this year and an inverted yield curve "helps

predict US recessions."

     However, somewhat in line with Brainard's comments Thursday, soon to be New

York Fed Chief John Williams said in a talk in Madrid on April 17 that while an

inverted yield curve was a "powerful signal of recessions," it does not appear

to be that way currently. 

--POLICY BEYOND NEUTRAL

     Brainard sees continued gradual increases in the federal funds rate as

"warranted", especially given that inflation has not yet been sustained at the

Fed's 2% target.

     Given her support of this gradual approach and her positive outlook, she

noted that this would suggest a policy path that will move gradually to neutral,

and "after some time, modestly beyond neutral."

     She also explained that the longer-run neutral rate is likely to remain low

by historical standards.

     "[T]he fiscal stimulus package is likely to provide a tailwind to growth"

in 2018, Brainard said. Her outlook for 2018 is positive given the fiscal

stimulus and the "still-accommodative financial conditions."

     Governor Brainard expects that these current tailwinds will boost the

neutral rate in the medium term, but does not expect the long-run neutral rate

to see much of an impact.

--RISKS ON HORIZON

     Brainard briefly mentioned that recent trade talks have brought

uncertainty, as "escalation in measures and countermeasures" could be disruptive

for the US but also globally.

     Reaffirming the fears of countermeasures, Canada announced earlier today

retaliatory taxes on US steel and aluminum.

     Additionally, she noted the recent political developments in Italy have

reintroduced some risk, while "financial conditions in the euro area have

worsened somewhat in response." Brainard noted that it is important to keep an

eye on these developments.

--RE-ANCHORING INFLATION IMPORTANT

     As the unemployment rate has been holding at levels that are lower than

estimates of the natural rate of unemployment, inflation should be moving

upwards. However, inflation has continued to be subdued, which Brainard sees as

a risk that underlying inflation "has softened."

     An important goal for the FOMC is re-anchoring underlying inflation at the

2% objective and running a "mild, temporary overshoot" could be helpful in

pushing underlying inflation back to target, Brainard explained.

     This comes on the heels of the BEA reporting earlier Thursday that the core

PCE year-over-year rate, the Fed's preferred measure of inflation held steady at

1.8% in April following a downward revision to the March pace from the 1.9% gain

originally reported.

--FORWARD-GUIDANCE LANGUAGE "STALE"

     The notion of the federal funds rate remaining below levels expected to

last in the longer run is considered to be "stale" by Governor Brainard. The SEP

shows the median for the fed funds rate in 2020 is at 3.4%, considerably higher

than the longer-run projection of 2.9%, causing the forward-guidance language to

"no longer serve its original purpose."

--MNI Washington Bureau; +1 212-800-8517; email: sara.haire@marketnews.com

[TOPICS: MMUFE$,M$U$$$]