Fed's Brainard Says Gradual Rate Hikes Remain 'Appropriate Path'

A gradual pace of interest-rate increases continues to be “the appropriate path” for Federal Reserve monetary policy as the economy receives a fiscal boost at a time of low unemployment, Governor Lael Brainard said.

“Continued gradual increases in the federal funds rate are likely to be consistent with sustaining strong labor market conditions and inflation around target,” Brainard said Thursday in the text of a speech at the Forecasters Club of New York. “This outlook suggests a policy path that moves gradually from modestly accommodative today to neutral — and, after some time, modestly beyond neutral.”

Brainard’s speech validates investor expectations that the central bank will raise the benchmark lending rate when officials next meet June 12-13, and her outlook appears similar to the policy path published by the Federal Open Market Committee in March. At that time, central bankers forecast the federal funds rate that keeps supply and demand in balance in the economy over the longer run at 2.9%. They forecast the rate would be 3.4% at the end of 2020.

“It seems likely that the neutral rate could rise in the medium term above its longer-run value,” Brainard said. “I expect current tailwinds to boost the neutral rate gradually over the medium term but leave little imprint on the long-run neutral rate.”

The FOMC’s latest forecasts published in March show an even split among policy makers between three and four hikes for 2018, excluding outliers. Bets in financial markets on four rather than three hikes have faded in recent days as financial markets have been roiled by everything from political uncertainty in Italy and Brazil to U.S. trade disputes, conditions Brainard generally described as downside risks worth watching.

Brainard indicated that she is putting less weight on a flatter yield curve as an indication of too tight policy, partly because the term premium, or compensation investors demand for holding longer-term debt, on government bonds is lower than it was in the past.

“With the term premium today very low by historical standards, this may temper somewhat the conclusions that we can draw from a pattern that we have seen historically in periods with a higher term premium,” the Fed governor said.

Private forecasters surveyed by Bloomberg expect the economy to expand 2.8% this year, with inflation rising slightly above the Fed’s 2% target.

Economists including Sal Guatieri at BMO Capital Markets raised their second-quarter growth forecasts on Thursday after Commerce Department data showed consumer spending increased more than anticipated in April. The report also showed that inflation hit the Fed’s 2% target for the second straight month. Price gains have remained below target for most of the past six years.

“The sizable fiscal stimulus that is in train is likely to provide a tailwind to growth in the second half of the year and beyond,” Brainard said. “From a position of full employment, the economy will likely receive a substantial boost from $1.5 trillion in personal and corporate tax cuts and a $300 billion increase in federal spending, with estimates suggesting a boost to the growth rate of real GDP of about 3/4% this year and next.”