Fed's Kocherlakota Does Not Like What's Brewing in The Bond Market

        By Michael S. Derby
        Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said Tuesday rock-bottom borrowing costs in the bond market are not a positive vote on the economic outlook.
        "The low long-term yields are actually a source of unease to me" because they suggest investors are marking down the economy's long-term prospects, while indicating that it's possible the Fed will have less room to maneuver when it comes to future monetary policy making, the official told reporters after a speech in New York.
        When it comes to weak growth, "investors seem to think about this as a relatively persistent problem," the official said.
        Mr. Kocherlakota was responding to a question about the state of borrowing costs. Even as the Federal Reserve has moved closer to raising rates, bond yields have been falling, at a time when they would normally be rising to price in the prospect of higher short-term interest rates. Many view the drop in borrowing costs a reflection of the U.S.' value as a safe haven for money at a time where global economic conditions are deteriorating.
        The market's movements suggest that even if the Fed meets expectations and raises rates this year--something Mr. Kocherlakota strongly opposes--financial conditions will not reflect this change in Fed policy. New York Fed President William Dudley noted in a speech late last year a lack of market reaction to a central bank rate rise could force the Fed to be more aggressive with subsequent rate actions.
        In his prepared remarks, Mr. Kocherlakota said any move to raise interest rates this year could imperil the job-market recovery and undermine confidence inflation will move back up to 2%.
        In an event held by Market News International, Mr. Kocherlakota pressed forward with his long-running campaign against any move to raise interest rates in 2015. Most central bankers expect to boost rates off of near-zero levels this year, with key officials pointing to the middle of 2015 as the most likely time for action. Most in the markets also expect the Fed to raise rates in the summer as well.
        In his remarks Tuesday, Mr. Kocherlakota reiterated that raising rates at a time when the job market still has room to improve further, in an environment where price pressures are weakening, is simply a bad idea. The official held a voting role on the monetary-policy-setting Federal Open Market Committee last year and dissented three times as Fed officials moved closer to lifting rates. Mr. Kocherlakota doesn't have a vote this year, and is set to leave his bank at the start of next year.
        Mr. Kocherlakota said in his speech that rate rises would make it harder to keep the economy adding jobs at the current pace. "The job market is--finally--on a highly desirable upward trajectory. We are more likely to continue on that welcome trajectory if the FOMC does not tighten monetary policy in 2015," the official said.
        Mr. Kocherlakota believes the Fed is playing a dangerous game with inflation. The Fed has fallen short of achieving its 2% price target for over two years now, and crashing oil prices mean headline inflation will likely be negative over the start of the year, if not longer. If the Fed raises rates in this inflation environment, Mr. Kocherlakota worries the public will come to believe the Fed doesn't actually care all that much about achieving its price target.
        "My own current assessment is that it will take a few years for inflation to return to 2% from its current low level," Mr. Kocherlakota said. "Raising the target range for the fed funds rate in 2015 would only further retard the pace of the slow recovery in inflation," he said.
        While the central banker didn't call for the Fed to take additional steps to push up inflation and drive down unemployment, he said the Fed could have done more in the past.
        "The FOMC underperformed in the past three years with respect to the price stability mandate and the employment mandate," he said. "By providing somewhat more stimulus, the FOMC could have stimulated at least somewhat more employment growth, without creating undue inflation."
        Mr. Kocherlakota told reporters after his speech that while he's seen hints of rising wage pressures, he's not expecting any big gains any time soon. He also said it's possible the economy's natural rate of unemployment is now below 5%. The U.S. jobless rate currently stands at 5.6%.
        He also told reporters the big drop in oil prices means that observers should pay closer attention to core price measures, which take out energy and food costs, as everyone tries to figure out the future direction of inflation.
        (END) Dow Jones Newswires

        January 13, 2015 19:05 ET (00:05 GMT)

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