MNI Policy:Fed's Kaplan:Gradual Move To Neutral Is Appropriate

By Sara Haire

     WASHINGTON (MNI) - In an essay entitled "Where We Stand: Assessment of

Economic Conditions and Implications for Monetary Policy," Dallas Fed Bank

President Rob Kaplan explained that while his outlook remains positive, there

could be risks worth paying attention to that may affect the outlook.

--5 Things We Learned From Dallas Fed Bank President Rob Kaplan's Essay.

- U.S. trade policy continues to permeate through discussions, especially in

regards to what effect it may have on the outlook and how the Federal Reserve

views it. Dallas Fed President, Rob Kaplan addressed the issue head on and

explained that U.S. trade policy, when coupled with worker shortages could pose

a negative risk to the outlook. He also said that the trade relationships with

Mexico and Canada specifically deals with "intermediate goods," which "are more

indicative of integrated supply chain and logistics arrangements which have

allowed U.S. companies to add jobs and increase their global competitiveness."

If these trade relationships are not rectified, the "U.S. would likely lose

market share to other countries, particularly in Asia," Kaplan explained.

- The Fed funds rate currently stands at 1.75% to 2.00% and the median

longer-run projection of where interest rate policy should reside according to

the June SEP showed 2.875%, indicating a few more rate increases along the way.

Kaplan, however, said that he believes the neutral rate stands somewhere between

2.50% and 2.75%, so a bit lower than the median projection. Kaplan explained

that the Fed should continue raising the Fed funds rate until they reach this

"theoretical concept" of neutral. Once there, Kaplan said he would be "inclined

to step back and assess the outlook for the economy and look at a range of other

factors--including the levels and shape of the Treasury yield curve--before

deciding what further actions, if any, might be appropriate."

- Kaplan touched on the yield curve to say that "it is worth paying attention to

given the high historical correlation between inversions and recession." He also

explained that in his own view, the short end of the yield curve is reacting to

the Fed's policy expectations while the longer end is telling him that "while

there is substantial global liquidity and search for safe assets, expectations

for future growth are sluggish-- and this is consistent with an expectation that

U.S. growth will trend back down to potential." He also explained that the

"shape of the curve suggests...we are "late in the economic cycle." This differs

slightly from Atlanta Fed Bank President Raphael Bostic's comments about the

yield curve yesterday when he pledged to "not vote for anything that will

knowingly invert the curve."

- "Cyclical forces are creating upward pressure on inflation" said Kaplan,

citing the tight labor market and higher input costs. He also said, however,

"strong structural forces--particularly automation and globalization--are

helping to mute the inflationary impact of these cyclical forces." Kaplan said

that these factors are important to consider when determining the appropriate

monetary policy stance. In terms of the near-term for inflation, Kaplan

explained that Dallas Fed economists expect inflation will remain around the

Fed's 2% target through the end of the year. Kaplan also cited the Dallas Fed's

"Trimmed Mean PCE inflation rate" which removes extreme upward and downward

prices, and that stands at 1.9% and is expected to reach 2% by the year's end.

- The economy is expected to be strong during 2018 due to a number of factors

according to Kaplan, including a "strong consumer sector, improved prospects for

business investment due to tax incentives, solid global growth and substantial

fiscal stimulus due to recent tax legislation and budget agreements." However,

he said that his team in Dallas has retained that 2019 and 2020 will likely be

more moderate as the effects from fiscal stimulus dissipates and monetary policy

"approaches a more neutral stance." He said that "potential GDP growth is likely

to be more muted than we have historically experienced due to the impact of four

key structural drivers: demographics, Lagging Education and Skill Levels, The

Potentially Unsustainable Path of U.S. Government Debt to GDP, and

globalization.

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

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