StL Fed's Bullard: More Hikes Would Inhibit Return to 2% Infl

--Would Not Support Further FFR Increases In Near Term; 'Should Remain on Pause'

--Calls Median Fed Forecast for Rate Hikes 'Unnecessarily Aggressive'

--Support Sept Reinvest Move; Sees Little Upward Pressure on L-Term Yields

By Karen Mracek

     ST. LOUIS (MNI) - Not only does St. Louis Federal Reserve Bank President

James Bullard say he won't support more increases in the policy fed funds rate,

in an exclusive interview with MNI Tuesday he warns additional hikes may delay

when the Fed will hit its 2% inflation target.

     "Given the inflation outlook, which has deteriorated in 2017, I would not

support further moves in the near term," Bullard told MNI. "It's possible data

will turn around, but we'll have to see. I think for now we should remain on

pause."

     Furthermore, if the policy rate is raised according to the median forecast

of the Federal Open Market Committee, which calls for another rate hike this

year and three next year, "I would think of that as unnecessarily aggressive

given the data that we have on the economy," he said. "I think that would

probably inhibit inflation from moving towards 2%."

     Bullard last year adopted a regime-based framework for monetary policy. He

sees the U.S. economy currently in a low growth, low inflation, low rate regime,

and he said Tuesday he doesn't "see anything that is indicating a regime shift."

Since debuting his forecast, which does not include a forecast for longer run

rates, he has not advocated for additional rate hikes.

     Still he supported the two 25-basis-point increases this year, telling MNI

"I was willing to go along with the Chair's judgement and the committee's

judgement that we could nudge up the policy rate a little bit." 

     However, now, with weaker than expected inflation this year and no sign of

a regime change, Bullard seems less inclined to agree to another rate hike

anytime soon.

     "Expected inflation measures have deteriorated during the first half of

2017 broadly speaking," Bullard said, "and since that's a primary determinant of

actual inflation, it would not bode well for whether we can hit the inflation

target this year or further in the future."

     If the committee "pauses or just stays on hold" with the policy rate, he

said, "those inflation expectations might improve and you might be able to hit

your inflation target sooner."

     Bullard expects inflation to hit its 2% inflation target in 2018 but that,

he said, is conditional on "not raising the policy rate."

     The St. Louis Fed's forecast is for inflation to get back to the 2% target

"faster" than some on the committee expect, he explained, "but that's predicated

on keeping the policy rate more or less where it is, as opposed to the

committee's policy," he said, which is for additional rate hikes this year and

next.

     "I don't think we get to 2% this year, but I do think you can get to 2%

next year if you run a reasonable policy," he said.

     More than being opposed to near term rate increases though Bullard, who

will vote again in 2019 on the FOMC, said he's against the idea that another 200

to 250 basis points are needed to get back to normal.

     "I don't think that's the right context given the regime we're in," he

said. "I think we would do better to admit that we're in a low interest rate,

low growth, low inflation regime. We've got the right policy rate for that

regime."

     Of course, it is "possible things will change in the future and we'll

certainly keep our eye out for that," Bullard continued, "but given the data as

we have it today, and given the behavior of the economy as we see it today, we

got the right policy for today."

     With a "flat" forecast for the fed funds rate, Bullard said he is "the most

dovish person on the committee right now in terms of the path for the federal

funds rate."

     In fact, Bullard said the current rate of 1% to 1.25% "is at, or else close

to, the neutral rate that would keep inflation near target and unemployment low

and stable."

     If the FOMC made further moves, "I think what I would be most concerned

about is many consecutive moves of the type the rest of the committee is

contemplating which would move us up to a 3% policy rate," he said.

     "I think that is inappropriate given the regime we're in, given the

environment we're in, given the low inflation outcomes that we've observed,"

Bullard said. "I'd rather we didn't go on that kind of a path."

     The most recent GDP data validated the persistence of the low growth

regime. GDP growth in the first quarter, recently revised to 1.2% annualized,

"was tepid," Bullard said. 

     And while there was a rebound as expected in the second quarter, to 2.6%

growth in the first estimate, "if you average out the second quarter with the

first quarter, you get back to 2% on average for the first half of the year," he

said. This is "exactly what we've been saying and is very consistent with what

happened in 2015 and 2016."

     While Bullard does not see another rate hike as long as the economy stays

in this low growth, low inflation regime, he does want to move on the balance

sheet reduction plan "sooner rather than later."

     "I'd be ready to go at the September meeting," Bullard said. This is

largely when markets expect an announcement to come on the commencement of the

plan to end reinvestments.

     The "very workable" plan is "a very, very mild initial approach to balance

sheet reduction," Bullard said, adding "almost nothing happens initially and

then it gradually ramps up over many quarters."

     The plan, as outlined at the FOMC's June meeting, would begin with initial

caps on reinvestments of $6 billion per month for Treasuries and $4 billion per

month in mortgage backed securities, climbing over 12 months to $30 billion and

$20 billion, respectively.

     "I think it's a good plan and I think it would be prudent for us to allow

this passive run off of the balance sheet," Bullard said. It also would not have

"very much effect on yields," he said, and what effects it does have would be

"very mild and stretched out over a period of time -- two years or more."

     Bullard describes it as a normalization of the yield curve. The passive

runoff of the Fed's now $4.5 trillion balance sheet "would put a little bit of

upward pressure on long term yields," he said, "so that you're allowing the

yield curve to not be distorted as much by Fed policy as it otherwise would be.

I think that would be healthy for the U.S. economy."

     As a policy matter, the Fed's quantitative easing programs and now large

balance sheet "are distorting the yield curve relative to what it otherwise

might be," he explained. While this was intentional at the zero lower bound,

when the FOMC decided not to take the policy fed funds rate into negative

territory, "it's not clear now" that it is the Fed's intention, Bullard said.

     Now that the Fed is normalizing its policy, "you should normalize the

policy rate, but you should also normalize the longer-term rates as well in

tandem so you get a more normal yield curve than you would have under the large

balance sheet policy," he said.

     "We are depressing longer term rates with balance sheet," Bullard said, and

moving forward with the plan to gradually end reinvestments "should release some

of the pressure."

--MNI Washington Bureau;tel: +1 202 371-2121; email: karen.mracek@marketnews.com

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