One of the Federal Reserve’s top policymakers has warned of increased risks to US growth and flagged up a troubling fall in inflation expectations, as caution continues to percolate through the central bank.
Bill Dudley, president of the New York Fed, said hazards facing the US have escalated amid this year's market turmoil and worries about emerging market growth, although he has not yet fundamentally marked down his economic projections.
Should the turmoil in markets persist, it would trigger a “more significant downgrade” to his outlook, Mr Dudley said. He said a further fall in market and survey-based inflation expectations would be “worrisome”, as doggedly low inflation could eventually become entrenched in investors and consumers’ outlooks.
Since lifting rates in December for the first time since 2009, the Fed has appeared increasingly wary of following with another increase too soon, preferring to hold fire and assess what damage – if any – the tightening of financial conditions and slowdown in China will do to US growth.
Some Fed officials have been blunt. Last week Lael Brainard, a Fed governor who expressed public anxiety about tightening late last year, said she expected shocks from abroad to prompt the Fed to lift short-term rates by less than some observers had expected.
As part of the inner circle of Fed rate-setters, Mr Dudley’s views are closely watched. His speech cites factors such as the persistent drag of low energy prices and the high dollar on actual inflation data which depressed the chances of a return to the Fed’s 2 per cent target.
“At this moment, I judge that the balance of risks to my growth and inflation outlooks may be starting to tilt slightly to the downside,” his speech says.
The Fed declined to weigh up the risks in its January statement, preferring to stress the uncertainty and draw no conclusions. The Fed next meets from March 15th-16th and its statement on the risk factors will be key. If downside risks predominate, investors will further push back expectations for the next rate increase, having already largely ruled out a move in March.
Fed officials are confronting a mixed picture as they size up prospects, with the US economy continuing to register steady growth and corporate hiring even as the outlook dims overseas, with emerging market growth particularly shaky.
Official figures on Friday morning showed the US economy grew more rapidly than previously estimated in the fourth quarter of 2015, while inflation picked up in January along with household spending.
But data in other big markets have been less encouraging. Peter Praet, an executive board member at the European Central Bank, warned on Friday that global growth was "losing momentum" and that weak pricing pressures were a signal of poor world demand.
A key indicator will come on Friday, as the latest jobs figures for the US are released. Mr Dudley said he continued to expect the “core strengths” of the US economy to reassert themselves as transient factors dissipated, predicting that the US should see 2 per cent real gross domestic product growth this year. That should help to further reduce the unemployment rate, already below 5 per cent.
Mr Dudley was particularly worried about inflation expectations, which central banks see as key to delivering stable price growth. Consumer surveys show these are falling: both the New York Fed’s own survey and that of the University of Michigan showed the lowest readings on record.
“Further declines in either measure would be worrisome,” Mr Dudley said. “These developments merit close scrutiny, as past experience shows that it is difficult to push inflation back up to the central bank’s objective if inflation expectations fall meaningfully below that objective.” Japan’s gloomy experience on inflation was “cautionary in this regard,” he added.
