Fed’s Dudley Drops Bombshell: Low Inflation “Actually Might Be a Good Thing”

Tuesday, August 15, 2017
By Paul Martin

by Wolf Richter
Aug 15, 2017

QE unwind in September, “another rate hike later this year.”

The media have been talking themselves into a lather about how the less-than-2% inflation would force the Fed to stop hiking rates. But William Dudley, president of the New York Fed and one of the most influential voices on the policy-setting Federal Open Markets Committee (FOMC), just dropped a stunning bombshell about low inflation – why it might be low and how that “actually might be a good thing.”

The kickoff for unwinding QE appears to be in the can. There’s unanimous support for it on the FOMC. It appears to be scheduled for the September meeting. The market has digested the coming “balance sheet normalization.” Stocks have risen and long-term yields have fallen, and financial conditions have eased further, which is the opposite of what the Fed wants to accomplish; it wants to tighten financial conditions. So it will keep tightening its policy until financial conditions are tightening.

QE was designed to produce the “wealth effect,” as Bernanke himself explained it to the public, where those with assets get wealthier and then spend some of that wealth in the real economy. Part one worked. Part two didn’t. Now the experiment is over and will be partially unwound. Asset holders are requested to hang on – that’s the message.

In his interview with the Associated Press (transcript), Dudley confirmed this. As the Fed allows its portfolio to “run down,” he said – dropping about $2 trillion of securities over the next few years – “the private sector has to absorb somewhat larger amounts of Treasury securities and agency mortgage-backed securities, that will probably put some modest upward pressure on long-term yields.”

So bond prices, which move in the opposite direction of yields, are going to decline. But no biggie; bond holders had it so good for so long.

And rate hikes?

He expects the economy to keep muddling through with growth at “around 2%.” He said, “We’re still on the same trajectory we’ve been on for several years.” This growth is “sufficient to continue to tighten the labor market.” While inflation is “somewhat below our objective,” he expects “to see firmer wage gains, and that will ultimately filter into inflation moving up towards our 2% objective,” but “it’s going to take time.”

The Rest…HERE

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