Right on Cue: Fed's Dudley Delivers Dovish Speech

Futures were negative following Friday's dismal job showing but that lasted only as long as the the market open.

Right on cue came dovish pronouncement from Fed governor William Dudley in a speech to a New Jersey audience on the regional and national economy.

Reuters reports Rate Hike Timing Now Unclear.

The timing of the Federal Reserve's interest rate hike, which would be its first in nearly a decade, is unclear and for now policymakers must watch that the U.S. economy's surprising recent weakness does not signal a more substantial slowdown, a top Fed official said on Monday.

New York Fed President William Dudley's comments were the latest sign that a string of disappointing economic data, including a sharp drop in jobs growth last month, is derailing a Fed plan to tighten monetary policy around mid-year after more than six years of rock-bottom rates.

In relatively dovish remarks to a business audience in Newark, New Jersey, Dudley did not repeat his refrain that a rate hike could reasonably be expected to come by mid-2015.

A permanent voting member of the Fed's policy panel and a close ally of Fed Chair Janet Yellen, Dudley repeated that the rate hike would come once the labor market improves more and when policymakers are reasonably confident that low inflation will return to a 2 percent goal.

"The timing of normalization will be data dependent and remains uncertain because the future evolution of the economy cannot be fully anticipated," he said, adding he expects the path of rate hikes to be "relatively shallow."

Low oil prices and the drop in domestic drilling will exert a "meaningful drag" on U.S. economic activity, he said. The strong dollar will continue to hurt U.S. trade performance, and has already shaved an estimated 0.6 percentage point from overall 2015 growth, he added.

Longer term, he said the Fed's key policy rate will probably rise to only about 3.5 percent, lower than previously thought.

Dudley has been under political pressure for perceived regulatory missteps by his New York Fed, with lawmakers and even one former Fed official floating changes. But Dudley defended the status quo on Monday, saying his Fed bank should continue to play a key role in monetary policy during periods of stress.

Text of Dudley Speech

Reuters, as is typical from mainstream media, did not bother linking to the text of Dudley's speech.

Inquiring minds may wish to read Dudley's Speech on the Regional and National Economy at the New Jersey Performing Arts Center, Newark, New Jersey.

His speech was certainly on the dovish side. Yet, it did contain many positives.

Dudley Snips

Economic performance in this cycle has been disappointing compared to historical patterns.  ... despite very accommodative financial conditions and record corporate profits, growth of business fixed investment has been tepid. 

Looking forward, my outlook for 2015 is that economic growth will be close to the pace of the past two years, supported by continued solid fundamentals and accommodative financial conditions.  If I am correct, then this would lead to a further reduction of labor market slack, with the unemployment rate approaching 5 percent by the second half of the year.

The pace of improvement in the labor market has slowed in recent months from the strong pace at the end of last year. Nonfarm payroll employment increased in the first quarter by about 200,000 per month, well below the pace of the fourth quarter. This slowdown was broad-based, with job growth slowing in both the goods-producing and the service-providing sectors.

The unemployment rate was 5.5 percent in March: analysis by my staff suggests that the unemployment rate is nearing the point where we may begin to see a pickup in the pace of real wage gains. If this proves correct and unemployment continues to decline as I expect, then these stronger wage gains could help support solid income growth even if the pace of employment growth slows.  However, it will be important to monitor developments to determine whether the softness in the March labor market report evident on Friday foreshadows a more substantial slowing in the labor market than I currently anticipate.

The March labor market report is another indicator that the first quarter is likely to be quite weak.  Our current projection is that the economy will grow at about a 1 percent annual rate in the first quarter of 2015.  This softer performance is suggested by a wide range of recent indicators that have surprised to the downside over the past couple of months.  Examples of such indicators include retail sales, the ISM manufacturing index, manufacturing production and orders, and single-family housing starts.

Overall, I view these downside surprises as reflecting temporary factors to a significant degree.  For example, some of the recent softness is likely due to yet another harsh winter in the Northeast and the Midwest.  My staff’s analysis of a measure of both the amount of snow and the population affected indicates that January and February weather was 20 to 25 percent more severe than the five-year average.  Such large deviations appear to have meaningful negative impacts on a number of economic indicators.

Even so, there are some downside risks to the growth outlook.  In particular, the steep decline in crude oil prices is likely to lead to a further sharp drop in U.S. oil and gas investment.  Additionally, the significant rise in the value of the dollar is likely to lead to weaker U.S. trade performance.

Turning to the negatives, the support to growth from rapidly rising U.S. oil production almost certainly will fade away.  U.S. oil production has been rising rapidly for several years, due largely to new technology that has expanded the amount of oil that can be recovered from existing wells and that has facilitated shale oil production by fracking.  Now, with prices dramatically lower, U.S. oil exploration and drilling activity is falling off very sharply. This will exert a meaningful drag on economic activity.

Another significant shock is the nearly 15 percent appreciation of the exchange value of the dollar since mid-2014.  Such an appreciation makes U.S. exports more expensive and imports more competitive.  My staff’s analysis concludes that an appreciation of this magnitude would, all else equal, reduce real GDP growth by about 0.6 percentage point over this year.

Turning to inflation, the data continue to come in below the FOMC’s objective of a 2 percent annualized rate for the personal consumption expenditures (PCE) deflator.  The twelve-month change of the total PCE deflator was 0.3 percent in February, with the core PCE deflator at 1.4 percent.  Despite this, my expectation is that inflation will begin to firm later this year.  In particular, most of the impact from the decline in energy prices that has weighed down overall inflation is likely over.

Monetary Policy

As the FOMC has consistently communicated, the timing of lift-off will depend on how the economic outlook evolves.  As I have discussed, the labor market has improved substantially and I expect to see inflation begin to firm later this year.  If this labor market improvement continues and the FOMC is reasonably confident that inflation will move back to our 2 percent objective over the medium-term, then it would be appropriate to begin to normalize interest rates.  At the March meeting, the FOMC removed language from the statement that indicated that we would be patient in beginning the process of normalizing monetary policy.  But, as Chair Yellen remarked in her most recent press conference, removal of “patient” from the statement does not indicate that we will be “impatient” to begin to normalize monetary policy.  Rather, the timing of normalization will be data dependent and remains uncertain because the future evolution of the economy cannot be fully anticipated.

Whenever the data support a decision to lift off, I think it is important to recognize what this would signify.  It does not mean that monetary policy will be tight.  We will simply be moving from an extremely accommodative monetary policy to one that is slightly less so.  It also will be a positive signal about the progress we have made in restoring the economy to health.  In my view, it would be a cause for celebration, because it would signal that the FOMC believes that slightly higher short-term interest rates are consistent with its objectives of maximum employment and price stability.  Near-zero short-term interest rates and a larger Federal Reserve balance sheet were designed to be a temporary extraordinary treatment to help the economy regain its vitality, and not a permanent palliative.

How high will short-term rates ultimately need to go?  I think this issue is very difficult to judge for a number of reasons.  First, it depends on how financial market conditions evolve in response to our monetary policy adjustments.  Second, it depends on other factors, such as real potential GDP growth, which, in turn, depends on the growth rates of the labor force and of productivity.  My current thinking is that the long-run nominal federal funds rate consistent with 2 percent inflation is somewhat lower than in the past.  My point estimate is 3½ percent, but I wouldn’t bet the farm on this.  I have considerable uncertainty about this estimate.

Key Sentence

"Whenever the data support a decision to lift off, I think it is important to recognize what this would signify.  It does not mean that monetary policy will be tight.  We will simply be moving from an extremely accommodative monetary policy to one that is slightly less so."

Outlook Brighter

Flashback December 2: New York Fed President William Dudley says "Dreary Days for U.S. Economy May Be Over".

Despite some headwinds, Dudley is optimistic that America could grow closer to 2.5% to 3% in the coming year instead of the ho-hum 2% growth that has been a hangover of the Great Recession.

"The U.S. economic outlook looks brighter, with growth likely to be somewhat above the trend of the past five years," Dudley said in a speech on Monday

In fact, Dudley thinks the economy could soon be healthy enough for the central bank to lift interest rates off the ground.

He's signaling the Fed will likely be able to raise interest rates in 2015.

"While raising interest rates is often portrayed as a difficult task for central bankers, in fact, given the events since the onset of the financial crisis, it would be a development to be truly excited about," Dudley said.

"When the [Fed] begins to raise its federal funds rate target, this would indicate that the U.S. economy is finally getting healthier," he explained.

In response, I commented Fed Governor Dudley "U.S. Economic Outlook Looks Brighter"; Ring! Ring! Goes the Bell: "Fed Governors tend to be among the best contrary indicators you can find, so much so that I have to wonder if a bell just rang. William Dudley is ready to sell. But I ain't buyin' it."

Dudley On the Economy




In spite of his brighter outlook about which he is now uncertain, Dudley only wants to go from an "extremely accommodative monetary policy to one that is slightly less so," precisely the cue the market was seeking.

One of these lovie-dovie speeches will be a major sell signal, but the Wall Street salivating dogs won't recognize it when it happens. Perhaps no one will.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com