MNI:Fed's Bullard: 'Crunch Time' on Yield Curve Inversion Risk

--Current Policy Rate Pressing Against 'Upper Bound' of Neutral

--Low Market-Based Measures Of Inflation Reason for Caution on Rate Increases

--Labor Market At 'Equilibrium,' Could Stay For A Long Time

By Sara Haire

     WASHINGTON (MNI) - Further interest rate increases out of the Federal

Reserve could cause the yield curve to invert as soon as September, a reliable

signal of an impending downturn, Federal Reserve Bank of St. Louis President

James Bullard said Friday. 

     He again urged caution in hiking rates, saying the Fed's current target

range of 1.5% to 1.75% "is already pushing against the upper bound of the

neutral level today." 

     Bullard, who does not vote on rates this year, is among those most

concerned over the diminishing spread between short-term and long-term bond

yields, reiterating his warning first issued last month that if the yield curve

inverts, it could be a sign of an impending economic downturn. 

     Other Fed officials including Chair Jay Powell, San Francisco Fed President

John Williams and Cleveland Fed chief Loretta Mester, all Federal Open Market

Committee voters this year, have suggested the recent flattening of the yield

curve does not signal the U.S. economy is hurtling toward recession. 

     --DOWNTURN COULD FOLLOW

     Given low market-based measures of inflation and rising short-term rates,

further rate increases could cause the yield curve to invert, Bullard said.

     "It's getting close to crunch time," he told reporters after giving a

presentation to the Springfield Area Chamber of Commerce in Springfield, Mo. The

yield curve could invert after just two more rate hikes, he cautioned, adding,

"I don't think it's likely to happen that fast, but in the next year it could be

a tangible issue." 

     But research suggests policymakers might still have two to eight quarters

to think about what to do after a yield curve inversion and before an economic

downturn hits, he said. 

     Minneapolis Fed Bank President Neel Kashkari has made similar comments,

saying the flattening of the yield curve indicates nearing neutral policy

territory, implying the Fed should reconsider its gradual tightening policy

path.

     By contrast, Williams of the San Francisco Fed recently said that as

interest rates rise, the flattening of the yield curve "is a normal part of the

process," something Fed Governor Randal Quarles has also maintained.

     --SLIGHT OVERSHOOT OK

     The current policy rate is "likely neutral" already, Bullard said, and the

Fed should not "disturb" the "champagne economy," with an unemployment rate

below 4% and inflation at or below 2%. 

     While the confidence bounds around the real neutral rate of interest is

very wide, empirical evidence suggests it is somewhere below 0, meaning the

nominal rate is below 2%, he said. 

     The "full steam ahead" attitude towards the current normalization path

should be tempered given also the low market-based measures of inflation

expectations, leeway for higher business investment and a labor market at

equilibrium, he said.

     The Fed has "already been preemptive in keeping inflation and expectations

in line," Bullard told reporters. "I have no problem with some overshooting of

the target," he added, joining the slew of policymakers who have reiterated the

"symmetric" nature of the Fed's 2% inflation target.

     There does not appear to be a risk of an inflation breakout, he said, and

markets appear to agree. "Financial markets believe there is currently little

inflationary pressure in the U.S.," he said, another reason to be patient in

tightening, Bullard asserted.

--WATCHING INVESTMENT, TRADE 

     Another reason for the Fed to take a pause, Bullard noted, is to allow

business investment "room to grow." The impact of the recent corporate tax

reform is still being speculated upon, but Bullard asserted that it is possible

the economy could grow more rapidly with stoking inflation. 

     Several Fed officials have warned that the uncertainty of trade policies

poses a large risk to business investment. Bullard, in response to a question

asked by MNI, said that the risks may be more balanced when it comes to the

Trump administration's trade policy, depending on the outcome of the

negotiations.

     Further, Bullard seems confident that the tight labor market is not and

will not exert much pricing pressures. 

     While the labor market has tightened, he said there there have been no

signs of overheating. The market is in "equilibrium," and could remain there for

a long time, he said. 

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

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