MNI: Logan Says Higher Term Premium Could Mean Fewer Fed Hikes

Dallas Fed President Lorie Logan said Monday there could be less of a need to raise interest rates further if long-term interest rates remain elevated because of higher term premiums.

"However, to the extent that strength in the economy is behind the increase in long-term interest rates, the FOMC may need to do more," she said in prepared remarks.

The Dallas Fed president said recent inflation developments have been encouraging but "it is still too soon to say with confidence that inflation is headed to 2% in a sustainable and timely way." The labor market is still very strong, and output, spending and job growth are beating expectations, she said. She also suggested the need to see more softening in labor conditions than what was seen in 2019.

"I expect that continued restrictive financial conditions will be necessary to restore price stability in a sustainable and timely way. I remain attentive to risks on both sides of our mandate. In my view, high inflation remains the most important risk. We cannot allow it to become entrenched or reignite."

TERM PREMIUM

Logan argued the decomposition of recent yield curve moves is an important input into appropriate monetary policy, but stressed calculating this "decomposition is anything but straightforward." One back-of-the-envelope estimate Logan offered suggests that more than half of the total increase in long-dated yields since the July FOMC reflects rising term premiums.

Overall, the Dallas Fed chief concluded "there is a clear role for increased term premiums in recent yield curve moves. But the size and persistence of the contribution are subject to uncertainty."

Higher term premiums result in higher term interest rates for the same setting of the fed funds rate, all else equal. Thus, if term premiums rise, they could do some of the work of cooling the economy for us, leaving less need for additional monetary policy tightening to achieve the FOMC’s objectives, she said in a National Association for Business Economics speech.

"The persistence of all these changes also matters. If technical factors are temporarily raising term premiums, for example, monetary policy shouldn’t overreact."

Logan also suggested the economy's recent resilience could mean higher interest rates for longer. "I’m starting to take some signal from that resilience, not only about the rates needed to restore price stability in the next few years, but also about the rates that will need to prevail to sustain price stability and maximum employment over a much longer horizon," she said.