Fed President & CEO James Bullard of the St. Louis Branch of the Federal Reserve doesn’t appear to be as optimistic as some others. As you know, St. Louis is a key compiler of data, research and analysis for the entire FRB system.
Here are some key points from his April 10, 2017 presentation at the Australian Centre of Financial Studies in Melbourne, titled: The U.S. Macroeconomic Outlook.
- The U.S. economy has arguably converged to a low-growth, low-safe-real-interest-rate regime, a situation that is unlikely to change dramatically during 2017.
- The Fed can take a wait-and-see posture regarding possible changes to U.S. fiscal and regulatory policies.
- The U.S. policy rate can remain relatively low and still keep inflation and unemployment near targets.
- Now may be a good time for the FOMC to consider allowing the balance sheet to normalize by ending reinvestment.
Bullard went on to say that GDP appears to have stabilized around the 2% level and is expected to remain there for the remainder of 2017. The six sources of GDP estimates ranged between 0.6% and 2.9%.
He said the labor market improvements have slowed over the last 18 months, the unemployment rate has only barely declined and employment (NFP) has slowed to 1.5 % today from 2.3 percent a year earlier. Private hours, the average hours per week worked in private industry, growth has also slowed from 3.4 % in Feb. 2015 to 1.4 % today.
He noted that U.S. labor productivity growth is driven by labor force and productivity trends and that U.S. labor productivity has been growing at a rate of only 0.4% since early 2013, whereas it had grown at a rate of 2.3 percent per year from 1995 to 2005 and thus, the key to increasing GDP is to have a more rapid productivity growth. The statistical probability modeling of this, is that the U.S. economy is most likely to remain in a low growth regime.
On inflation, Bullard said based on the Dallas Fed, the trimmed-mean inflation rate, has barely increased in the last several years and was at 1.9% in February and is expected to remain near the 2% target.
He then showed a graph and spoke on the global phenomenon of the low-safe-real-rate regime with the 1 year treasury yields around the -1% to -1.5% range with Japan, Germany, and the UK about the same. Another chart showed the divergence of the 8% to 10% return on all capital as compared to the declining negative 1 year treasury yield.
His conclusion was that real rates on government paper are extremely low internationally and will remain low so the U.S. policy rate will likely also remain low.
With policy rate projections, he stated that the difference between the St. Louis Fed’s view and the views in the FOMC’s Summary of Economic Projections (SEP) is that there are two factors. 1. We do not see any real changes in productivity growth or higher retunes on short term government paper and 2. we do not see any change in the real rate of return whereas the DEP suggests it will go back to 2001 to 2007 levels. His conclusion was that St. Louis predicts a relatively flat policy rate over the next two to three years, with some upside risk. He showed a chart with the FOMC rate hikes since 2015 with their projections going near the 300 Basis Point range whereas, it has in reality stayed under 1% even after the last rate hike of .25 BP. St. Louis is obviously predicting the Fed Funds Rate will remain low under the current macroeconomic environment and this is not likely to change very much.
What if: He then asked the question. Will the new fiscal and regulatory policies move the U.S. into a higher growth regime? The Fed can only wait and see.
- Deregulation could improve productivity growth.
- Infrastructure spending could also improve productivity growth
- Tax reform could also improve productivity growth.
The than talked, as others from the FRB are discussing, about the Fed’s enormous balance sheet which has grown, based on his chart, from about $800 billion in late 2007 to $4.5 trillion today.
- The FRB policy is currently putting upward pressure on the short end of the yield curve via actual and anticipated policy rate hikes.
- It is also putting downward pressure on some of the other yields within the curve.
- He then says that this “twist operation” has no known theoretical basis, meaning as Milton Freidman said, we’re in uncharted waters.
- A more natural normalization would allow the yield curve to adjust appropriately.
In his words: The U.S. economy has arguably converged to a low-real-GDP growth, low-safe-real-interest-rate regime. Because of this, the Fed’s policy rate can remain relatively low while still keeping inflation and unemployment near goal values. The new fiscal and regulatory policies could impact productivity growth and therefore improve the pace of real GDP growth. The Fed can wait to see how these new policies evolve. Ending balance sheet reinvestment may allow for a more natural adjustment of rates across the yield curve as normalization proceeds.