Federal Reserve Bank of New York President William Dudley argued for continued caution over the path of U.S. interest rates, given uncertainty over the global outlook, but warned that traders who have been ruling out an interest-rate increase later this year are growing too complacent.
In remarks prepared for a joint central-bank seminar in Bali between the New York Fed and Bank Indonesia, Mr. Dudley also laid out a defense of the Fed’s communications to Wall Street amid recent criticism that they have left traders increasingly out of step with the central bank.
In recent months, Fed officials have signaled potential interest rate increases are possible this year, but not all traders have been convinced the central bank will act.
Mr. Dudley said this dynamic doesn’t show the Fed’s inability to transmit policy guidelines to the market effectively, but rather highlight how expectations about the path of rates have shifted relative to one year ago.
At their rate-setting meeting last week, Fed officials left its short-term rates unchanged. But they opened to door to an increase later this year, possibly as early as September, concluding that risks to the outlook appear to have diminished.
Mr. Dudley attributed changing market bets partly to the Fed holding interest rates steady for longer than many expected. But he said his own baseline outlooks for growth and inflation had not changed notably in recent months.
“Compared to the start of the year, the expected timing of any further Fed interest rate hikes has been pushed back,” he said in prepared remarks. “Directionally, the movement in investor expectations towards a flatter path for U.S. short-term interest rates seems broadly appropriate.”
Mr. Dudley warned some traders were putting insufficient weight on the potential for near-term rate rises and said futures prices indicating the Fed will only be raise another quarter of a percentage point before the end of 2017 appeared “complacent.”
Given the potential for faster adjustment in policy if financial conditions ease, he warned, “It is premature to rule out further monetary policy tightening this year.”
The New York Fed official explained that it would be worse at this stage for the Fed to raise rates too soon and risk setting the economy off course, than moving slightly too late and having to adjust by raising rates more quickly.
He said the medium-term risks to the U.S. economic growth outlook were skewed to the downside. For one thing, he said troubles from the financial crisis haven’t fully dissipated seven years on, and “Evidence is accumulating that some of the headwinds are likely to prove more persistent.”
Another issue for the Fed is that, as overseas economies pursue more expansive monetary policy to stimulate growth, it pushes up the value of the dollar to reflect the expectations for higher interest rates in the U.S. relative abroad. If the Fed did not adjust its response to these developments abroad, “the stronger dollar could result in an undesired tightening of U.S. financial conditions,” he said.
Mr. Dudley said he expects annualized growth over the next 18 months of 2%, but there was no certainty his forecast would materialize. He said a sizable pickup in the pace of growth “seems unlikely,” in part because there has been some leveling off in the improvement of the labor market. Even so, the pace of hiring bounced back in June to a gain of 287,000 jobs, from just 11,000 in May.
On the potential downside, he listed the difficulty in assessing the longer-term fallout from Britain’s vote to exit the European Union in June, and how the so-called “Brexit” vote might impact international growth and trade, currency moves, and the perceived health of bank stocks.
“To date, the global financial market fallout from the Brexit vote has been short-lived,” he said. “The potential aftershocks pose medium-term downside risks to the global economy, and that these risks need to be monitored.”
He reiterated that U.S. monetary policy decisions are data dependent, saying policy makers have grown more transparent about their views and concerns. But he acknowledged there was “room for improvement” in official Fed guideposts, including in the uncertainty over individual officials’ economic forecasts.
“We tend to make relatively few changes to the statement language each meeting because of the acute market sensitivity to such changes,” Mr. Dudley said. “One could argue that this might not be the best practice to follow, but we should recognize that there would also be significant transition costs if we were to make more extensive revisions to the statement at each meeting.”