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MNI INTERVIEW: Fed's Bullard Mindful of Inflation Expectations

(MNI)

Break-even yields appear in line with the Fed's goals so far, St. Louis Fed President tells MNI.

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St. Louis Fed President James Bullard told MNI in an interview Monday that rising inflation expectations are so far consistent with a shift in the Federal Reserve's goal of making up for past undershoots of its 2% inflation target, and market-based measures bear watching for signs of any worrisome spike.

Bullard isn't too concerned about April's 4.2% inflation rate, and instead is monitoring market measures like the spread between nominal Treasuries and inflation-backed bonds.

"We were certainly expecting year-over-year comparisons to make the inflation number look hot -- that certainly happened," Bullard told MNI. "I don't think that those are the kinds of lasting increases of prices that you would call inflation, but I do think it's enough to have sent inflation expectations somewhat higher."

The rise in TIPS-based inflation break-evens to around 2.7% on a CPI basis is "suggests the committee will be able to move inflation somewhat above target for some time which is what the new framework is aiming for," he said.

PATIENCE ON TAPERING

Asked about his tolerance for higher inflation expectations, Bullard said break-evens at 2.75% for the CPI would be consistent with a reading of around 2.45% for the Fed's preferred PCE inflation gauge -- and thus his desired degree of overshoot. Bullard said he's also comforted by five-year forward contracts showing inflation ebbing in the latter portion of the coming ten-year period.

"Could it go higher? Absolutely. That's something I would want to look at and think about," he said. "If you had some expectation where let's say the five-year (TIPS breakeven) were considerably higher than it is today and then five-year/five-year forward was even higher than that, that would suggest a de-anchoring of inflation expectations and in that circumstance I think the committee would have to get more active in trying to reassure markets."

Bullard said he could raise his March forecast for 6.5% growth this year, though he hasn't formally gone back to revise that or his view inflation will register around 2.5%. "I'd now be willing to move that up somewhat," he said of his growth call.

Even with growth that Bullard thinks will be around an annualized 10% this quarter, he pushed back against talk from investors and former policymakers about a near-term tightening of monetary policy.

JOBS MOMENTUM

"I would like to see a more definitive end to the pandemic before we change monetary policy," Bullard said. "The probabilities are rising probably to pretty high levels that it will come to an end. But you'd really like it to be more definitively finished than it is today and then at that point we can open up discussions as to where to go next."

"It's important for Jay to open that discussion as opposed to members of the committee," he said, referring to Fed Chair Jerome Powell.

The Fed is currently buying USD120 billion a month of Treasury and mortgage bonds in order to support the economic recovery. The central bank has said it needs to see "substantial further progress" toward its stable price and full employment goals before officials begin reducing the pace of QE.

Bullard said he wasn't surprised by an April jobs report showing a net gain of just 266,000 new jobs, because the momentum should build more towards the end of the year.

SEEKING TIGHTER JOB MARKET

"April was a little bit too early to expect really big jobs numbers," he said. "You still have children at home in a lot of school districts in various states of flux. As of April, you still had a lot of people very nervous about the pandemic itself."

"Labor markets are tight. If you look at the unemployment-to-vacancies ratio it's one of the lowest readings we've seen and approaching the lows of the previous expansion," Bullard said.

Fed advisers have told MNI they see the prospect that April's jobs disappointment may not have been a one-off, because they believe labor market matching issues will lengthen the reversal of Covid-linked layoffs.

"We've made a lot of progress so far and with this booming economy I think we're likely to move even further in the direction of a tight labor market," Bullard said.