There is an increasing risk that the US economy has become trapped in a prolonged period of subdued growth that requires lower official rates than was previously expected, a leading Federal Reserve policymaker has warned.
Jerome Powell, a member of the Federal Reserve Board of Governors, said he was not in a hurry to lift rates, arguing for a “very gradual” path for any rises, while warning that the US outlook was still dogged by global risks.
“With inflation below target, I think we can be patient,” he told the Financial Times.
In his four years at the Federal Reserve, Mr Powell has demarcated himself for his willingness to get stuck into the nitty-gritty of financial markets, earning himself a reputation as the Fed’s markets governor.
But meeting the FT in a wood-panelled room at the Fed’s headquarters on Constitution Avenue, he appeared as much preoccupied by the longer-term US growth outlook as by the potential for market logjams and mishaps.
Economists led by Larry Summers, former Treasury secretary, have been propounding the sobering theory that the US may be mired in so-called secular stagnation — a trap of lethargic economic growth and depressed interest rates.
For a while the Fed resisted that dismal prognosis. But Mr Powell, a level-headed centrist on the rate-setting Federal Open Market Committee, appears increasingly alive to the possibility, even if he says secular stagnation is not his “baseline” expectation.
“I am more worried about it than I was,” he said. “The probability of an era of weaker growth, lower potential growth, for a longer period of time — that worries me more than it used to.”
To achieve economic growth forecasts, Fed rates will “just have to be lower than I thought,” he added.
One reflection of the quagmire is the gradual decline in Fed policymakers’ estimates for the long-term federal funds rate.
“I don’t think that process is over,” Mr Powell said. “The median estimate on the committee is 3 per cent for the long-term federal funds rate. It could be lower than that, in my view.”
Having lifted rates in December by a quarter point to a range of 0.25 per cent to 0.5 per cent and sat still since then, the Fed is weighing conflicting signals at home and overseas as it looks towards its September meeting.
The US economy, Mr Powell said, is “not full of risk right now”.
But he added: “The issue is that if you look around the world there are just a lot of risks that could affect us. So it is a US economy that is probably pretty close to its pattern of the last seven years, but the risks to us from the global economy are to the downside.”
He said it was hard to raise rates “in a world where everyone else is cutting and demand is weak around the world”.
“The expectation of rate increases has produced a big move up in the dollar since 2014, which has restrained growth.”
Mr Powell was speaking the day before the release of jobs data on Friday that beat expectations.
To support a rate increase, Mr Powell said that he would want to see strong growth in employment and demand; inflation heading back to 2 per cent and an absence of obvious “global risk events.”
Fed policymakers are still scanning for potential fallout from Britain’s vote to leave the EU, while questions hang over China’s growth outlook.
Asked if his preconditions could be satisfied as soon as the Fed’s September meeting, Mr Powell said: “In particular, I need to see two really good employment reports. And then it is a conversation. I wouldn’t be pounding the table saying we really need to raise rates.”
The former Carlyle Group partner — a keen athlete who cycles to work every day — has spent significant parts of his career at the sharp end of Treasury market structure.
He served in the Treasury under former President George H.W. Bush, helping to formulate the government’s responses to the Salomon Brothers scandal in 1991. The firm used fake bids to purchase more Treasury securities at auction than was permitted by one institution.
Mr Powell has recently been vocal on the intricate plumbing of markets, advocating the central clearing of so-called repo transactions in a bid to alleviate some of the capital concerns that big banks blame for their pullback from the market. Repo markets are integral to the functioning of the broader Treasury market, allowing financial institutions to borrow and lend securities short term in order to cover obligations to other counterparties.
But higher capital charges have made the transfer of Treasuries more expensive.
It is part of the industry’s explanation for why liquidity, the ease of buying and selling an asset, has declined in Treasury markets.
Mr Powell has spoken in chorus with the Fed and Treasury in rejecting the industry’s concerns that market liquidity has become markedly worse. But he remains attuned to the potential for problems to arise.
“Most of the time in most markets liquidity is okay. But it may be more fragile, and more prone to disappearing in stress situations,” he says. “There hasn’t been a liquidity-related incident that has had a significant effect on the real economy. That doesn’t mean it won’t happen.”
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