“Today I’m going to be the resident optimist,” Rosengren said in remarks on Jan. 13. “You don’t normally invite an economist onto the program to be the optimist in the group, but actually the economy is doing quite well,” he told an audience at the Connecticut Business & Industry Association.
Rosengren, who heads the Federal Reserve Bank of Boston, said he expects “almost ideal” economic outcomes in 2020—inflation close to the Federal Open Market Committee’s 2 percent symmetric inflation target, and continued labor market strength.
Still, he warned of risks to the hopeful forecast, admitting policymakers were navigating in largely uncharted waters in today’s low interest rate environment.
“As a practical matter, central bankers do not have much historical experience with extended periods where interest rates are running below the estimated equilibrium level while unemployment rates are, simultaneously, historically low. So we want to be alert to any potential risks emerging. … If these risks remain contained, my view is we will likely have another year of good economic outcomes.”
Inflation running hot as companies respond to labor shortages by raising wages is a chief risk, he said.
“More rapid than expected inflation remains a risk of running the economy with accommodative monetary policy and tight labor markets,” Rosengren explained.
Resonant of Rosengren’s view of upward wage pressure is a recent employment report from the National Federation of Independent Business (NFIB). It shows that, in December, finding qualified workers was the top problem for nearly a quarter of 10,000 business owners polled.
“The inability to assemble work teams is a key contributor to the comparably lackluster performance of the construction industry as evidenced by the December figures,” said NFIB Chief Economist William Dunkelberg. “Owners are raising compensation in order to attract more qualified applicants to fill open positions.”
The report showed near historic highs in the percentage of small business owners who raised or are planning to raise worker compensation.
‘Reach for Yield’
Rosengren said loose monetary policy could lead consumers and businesses to take on riskier investments, or “reach for yield.”
Bubbles in asset prices might ensue, posing a danger to financial stability.
“It is important to see and understand the risk that sustained low interest rates could place more pressure on real estate asset prices through reach-for-yield behavior—a scenario that preceded the 1990 and 2007 recessions. In certain scenarios, financial stability risks could potentially emerge as a problem for the otherwise benign forecast,” he said.
How dovish or hawkish the Fed’s policies are in 2020 will depend on inflation pressures and the possible emergence of threats to financial stability, he said.
“Certainly, the lack of inflationary pressure to date has provided one justification for accommodative monetary policy despite the duration of the recovery and a current historically low unemployment rate. However, maintaining interest rates below the consensus longer-run ‘equilibrium’ interest rate is predicated on both inflationary pressures not building up and financial stability concerns being contained,” Rosengren said.
Robert R. Johnson, Professor of Finance at Heider College of Business, Creighton University, echoed Rosengren’s view that interest rates were in the right place, adding that “the current accommodative monetary policy is appropriate, given the status of the global economy.”
“In November, inflation measured minus food and energy stood at 1.6 percent. The Fed’s inflation target is 2 percent. There are global disinflationary pressures, and the Fed can’t simply look at the U.S. economic situation in isolation,” he told The Epoch Times.
“The specter of inflation shouldn’t cause the Fed to tighten,” Johnson added. “It just means the Fed needs to be somewhat nimble in changing course if inflation does become significant.”
Allen Sukholitsky, Founder and Chief Macro Strategist at Xallarap Advisory, cited data showing more muted inflation pressures going forward.
“If the Fed has not reached its target after more than ten years of an economic expansion, the likelihood that it does so now is limited,” Sukholitsky told The Epoch Times.
“One piece of evidence is that average hourly earnings have already been weakening for almost a year. Another piece of evidence is the median CPI (Consumer Price Index)—which omits extreme price changes in order to provide a better signal of the underlying inflation trend. It has been higher than the most recent level only 20 percent of the time, over the last two decades.”
Fed Officials See No Need for Rate Cuts Despite Weak Factory Data
Rosengren’s remarks follow statements by other senior Fed officials who said they were comfortable with the central bank’s freeze on further rate cuts despite a weak factory data showing in December.
In separate interviews on Jan. 3, the Fed bosses said they have enough confidence in the strength of the U.S. economy to favor maintaining the central bank’s current policy of wait-and-see.
Cleveland Federal Reserve Bank President Loretta Mester, Dallas Federal Reserve Bank President Robert Kaplan, and Chicago Federal Reserve Bank President Charles Evans all said they’ve seen no justification to drop the central bank’s current “on hold” policy.
“I’m pretty happy with where policy is at the moment, and we’ll have to wait and see,” Mester said on Bloomberg.
“I don’t think we should be making any moves at this point” on interest rates, Kaplan said on CNBC.
When asked by Bloomberg whether he thought recently published weak factory data showed the economy is in trouble, Evans said, “It doesn’t shake my confidence.”
Mester and Kaplan will be voting members on the rate-setting Federal Open Market Committee this year, while Evans was a committee member in 2019.
Weak Factory Data
The U.S. manufacturing sector fell into its deepest slump in more than a decade in December, showing weak factory output, orders, and employment.
Production came in at 43.2 for December, which is a 5.9 percent month-over-month contraction in the index. Coupled with readings for both new orders and factory employment at multi-year lows, the ISM data showed continued decline in a sector buffeted by trade tensions.
A reading below 50 indicates the sector is in contraction, and December’s reading marked the fifth straight month below that benchmark level.
Typically, the ISM index would have to drop below 43 to signal the risk of a wider economic recession.
“Global trade remains the most significant cross-industry issue, but there are signs that several industry sectors will improve as a result of the phase one trade agreement,” Timothy Fiore, chairman of ISM’s manufacturing business survey committee, said in a statement.
The manufacturing sector had been under pressure for much of the second half of 2019, as tit-for-tat tariffs from the United States and China slowed the flow of goods between the world’s two largest economies and contributed to a cooling in the pace of global economic growth.
Last month, the two sides announced they had reached agreement on a “phase one” trade deal, and President Donald Trump said the accord would be signed Jan. 15 in Washington, and talks to cement a wider “phase two” deal would begin shortly.
Weakness in the manufacturing sector was one of the concerns that spurred the U.S. Federal Reserve to cut interest rates three times last year.
“We’re in a virtuous economic cycle now where low unemployment, continued job growth, and rising household income are the fuel powering consumer spending. Consumer spending is the pillar on which the U.S. economy rests, with 68 percent of economic output tied to it,” explained Greg McBride, Senior Vice President and Chief Financial Analyst at Bankrate, in comments to The Epoch Times.
“When that virtuous cycle starts to show cracks—such as rising unemployment that undercuts the ability and confidence of households to spend—that’s when we need to worry the expansion is coming to an end.”
Reuters contributed to this report.