Fed’s Rosengren sees case for rate rise

Posted on September 9, 2016

Eric Rosengren, Boston Federal Reserve president©Bloomberg

Eric Rosengren, Boston Federal Reserve president

The head of the Boston Federal Reserve said on Friday that a “reasonable case” can be made for a rate increase given the growing risk that the US economy and financial markets will overheat.

Eric Rosengren, a voting member of the Fed’s policy-setting board, said that “despite headwinds from abroad” the US labour market continues to “gradually tighten” while inflation is “slowly returning” to the Fed’s goal of 2 per cent annual growth.

    Indeed, the jobs market may “reach or even exceed full employment over the next year”, Mr Rosengren said.

    While the sluggish economic growth in the first half of 2016 came “well below” the pace Fed officials expected, it was probably caused at least partially by temporary factors, like inventory destocking, Mr Rosengren added.

    He issued a brighter outlook for the second half of the year, saying, “the combination of the relatively strong domestic demand and the restocking of inventories should provide a basis for growth to exceed 2 per cent over the next two quarters”.

    As a result, there is a rising risk that the economy could begin growing too rapidly and force the Fed to have to raise rates too quickly later down the line, potentially prompting a recession.

    “It is important to note that an overheated economy — one that significantly exceeds sustainable output and employment — would pose risks to maintaining full employment over time,” he said.

    “This problem could be compounded if delays in tightening earlier in the cycle lead to conditions that require more rapid increases in interest rates later in the cycle, risking a more pronounced slowing in growth and rise in unemployment”.

    At the same time, low rates may cause certain asset markets to “become too ebullient”, he said. In particular, Mr Rosengren pointed to the US commercial real estate market, where prices have “risen quite rapidly over the past five years, particularly for multifamily properties”.

    It is important to note that an overheated economy — one that significantly exceeds sustainable output and employment — would pose risks to maintaining full employment over time

    – Eric Rosengren, head of the Boston Federal Reserve

    “Because commercial real estate is widely held in the portfolios of leveraged institutions, commercial real estate cycles can amplify the impact of economic downturns as financial institutions need to write down the value of loans and cut back on lending to maintain their capital ratios,” he said.

    The US dollar edged up on the news, shedding a decline and rising by 0.2 per cent against six world currencies in morning trading in New York. Meanwhile, the yield on the two-year Treasury note, which moves in the opposite direction of its price, ticked up by as much as 2 basis points to 0.79 per cent.

    The remarks also sent the market-implied odds of a September rate rise up to 36 per cent, from 28 per cent on Thursday, according to Bloomberg data based on federal funds futures.

    The comments from the generally dovish-leaning Fed official come just weeks before the central bank’s September 20-21 meeting. Hawkish comments from Fed chief Janet Yellen late last month sent the market-implied odds of a 2016 rate rise jumping, but a string of disappointing economic data released over the past few weeks once again knocked them down.

    Given the potential problems caused by excessively low rates and the broadly upbeat economic data, “a reasonable case can be made for continuing to pursue a gradual normalisation of monetary policy”, Mr Rosengren said.

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