US ‘on verge’ of passing rate rise test

Eric Rosengren, Boston Federal Reserve president©Bloomberg

Eric Rosengren, Boston Federal Reserve president

The US is on the verge of meeting most of the economic conditions the Federal Reserve has set to increase interest rates next month, according to a member of the rate-setting Federal Open Market Committee.

Eric Rosengren, the president of the Federal Reserve Bank of Boston, told the Financial Times he was getting ready to back tighter monetary policy after financial and economic indicators swung in a positive direction after the Fed’s policy meeting in March.

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Until last week markets were putting extremely low odds on a summer rate increase, in part because of the dovish tone of Fed chair Janet Yellen’s last speech two months ago. That picture was transformed on Wednesday, as the Fed minutes from its April rate-setting meeting suggested it was preparing the ground for a second interest rate increase following the quarter point rise in December.

“I want to be sensitive to how the data comes in, but I would say that most of the conditions that were laid out in the minutes, as of right now, seem to be . . . on the verge of broadly being met,” said Mr Rosengren, who has a vote on rates this year as part of the regular rotation of regional Fed presidents on the FOMC.

To justify a move at its next policy meeting in June, the Fed set itself three tests: to see additional signs of a rebound in the economy in the second quarter, further strengthening in the jobs market and for inflation to carry on towards the Fed’s 2 per cent goal. While policymakers are divided over whether these conditions will all be met by next month, Mr Rosengren said he saw the preconditions for a June rise falling into place.

Mr Rosengren was one of the Fed doves last year but has recently become more bullish on the outlook.

His stance chimes with the findings of the latest FT survey of 53 leading economists which found that more than half — 51 per cent — expected the Fed to tighten monetary policy at one of its next two meetings. This was in stark contrast to market views as recently as the start of the month when concern over lacklustre global growth and choppy financial markets seemingly stayed the US central bank’s hand until 2017.

I want to be sensitive to how the data comes in, but I would say that most of the conditions that were laid out in the minutes, as of right now, seem to be . . . on the verge of broadly being met

– Eric Rosengren, president of the Federal Reserve Bank of Boston

Recently markets have been more buoyant as oil prices rose, the dollar eased and US economic data gained strength.

Analysing the Fed’s three tests for a June move, Mr Rosengren said the central bank had set a “relatively low threshold” for improvement on the growth front given first-quarter gross domestic product expansion was at an annualised rate of just 0.5 per cent. While job growth in April slowed from the roughly 200,000 monthly average in the first quarter, hiring was still “well above” what was needed for a gradual tightening of the labour market, he added.

Mr Rosengren said the US was “making progress on getting to inflation at 2 per cent”, given the higher oil price, the depreciation of the dollar over the past two months, and the firming of the core personal consumption expenditures measure of inflation to a year-on-year rate of 1.6 per cent.

“The reason I am more confident is we are getting better data,” he said.

The June 14-15 meeting of the FOMC takes place just a week before Britain’s referendum on its EU membership, but the vote should not stand in the way of US monetary policy changes unless it triggered a significant bout of market instability, Mr Rosengren said.

“Votes by themselves shouldn’t be a reason for altering monetary policy,” he said. “If we were experiencing significant changes in financial conditions that made us significantly alter the outlook going forward, that would be something that we should take into account.”

Mr Rosengren said demands in previous years for ultra-aggressive monetary stimulus had been vindicated as the US economy is springing forward with “a little more alacrity” than its trading partners. Now the picture is changing, however.

“Because we are closer to full employment and because we are closer to our inflation target I am more confident now that a more normalised situation makes sense,” he said.

The markets have been burnt by hawkish signalling from the Fed before — which partly explains why traders have been sceptical that the central bank will deliver anywhere near as much tightening as its policymakers’ March median forecasts suggested.

Going into last week investors were putting odds of just 4 per cent on a rate rise in June. Then came the Fed’s April minutes, and a strong signal that an increase will be an option at the June 14-15 rate-setting meeting.

“The reason they should believe this time is different is that the economic conditions are changing over this period,” Mr Rosengren said, referring to the spell since the Fed’s March meeting.

Financial markets have improved markedly since March, while the US consumer, which drives two-thirds of growth, has been showing greater verve, he explained. Private sector economists’ consumption forecasts for the second quarter were in the range of 3 per cent to 3.5 per cent, which points to broader growth of about 2 per cent, he argued.

“Stock markets globally have improved quite significantly. The data has been coming in better and not only in the United States but in many other parts of the world. Some of the headwinds we thought might be a significant problem as recently as March seem to be a little bit less of a significant problem as we go into June,” Mr Rosengren said.

With the fed funds rate still at roughly 35 basis points, “that is pretty low, given we are pretty close to full employment”, he said, while cautioning that he was not prejudging economic data that will emerge between now and the June meeting.

Mr Rosengren’s arguments for gradual monetary tightening are not confined to the labour market and inflation. He has been outspoken in warning about the possible side-effects from ultra-low interest rates in the property sector.

In Boston, as in many other big cities in the north-east and elsewhere, the main manifestation has been evident in rising commercial real estate prices. One way of reining in excesses in that sector is via regulatory tools, and the Fed last year issued guidance aimed at anchoring prudent lending standards in the industry.

But with non-bank financial institutions such as pension funds emerging as important drivers in the sector, the Fed’s supervisory weapons may not go far enough. Mr Rosengren said last November that if trends in the commercial property world continued unabated it could become an argument for a somewhat quicker pace of interest-rate increases by the Fed.

“I think we should continue to ask ourselves are we doing what we need to do to make sure that commercial real estate doesn’t grow to a point where it becomes a financial stability concern,” he said.

Additional reporting Eric Platt in New York

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