The U.S. Federal Reserve's projected path of rate hikes is "too hawkish for the current macroeconomic environment," especially considering what the markets are indicating through the yield curve, the president of the St. Louis Reserve Bank warned.
James Bullard said in a Sept. 5 presentation at a Euromoney conference in New York that the inverse relationship between unemployment and inflation — known as the Phillips curve — began dissipating after global central banks fixed 2% as an inflation target in the 1990s.
"In the current era of inflation targeting, neither low unemployment nor faster real GDP growth gives a reliable signal of inflationary pressure because those empirical relationships have broken down," Bullard said in his presentation.
Market-based inflation expectations, he added, remain "somewhat below" the Fed's 2% target. Coupled with a narrowing yield curve, the signals suggest that financial markets do not see excessive growth and inflation pressure over the period that the Fed's rate hike expectations are forecast. Markets have already priced in tax reform, trade concerns and other issues, he said.
In response to questions after the presentation, Bullard said his "best guess" for when the yield curve might invert would be some time this year or next. He added, however, that the inversion would only be meaningful if it was persistent and that there is always a lag between inversions and recessions.
Bullard said the gradual rate increases and balance sheet normalization the Fed had already undertaken would provide the cushion needed should economic shocks require the central bank to reverse course quickly.
"We've already been pre-emptive against incipient inflation pressure — we didn't wait for inflation to get above target," he said. "We also started to reduce the size of the balance sheet."
"In retrospect [the Fed] played all of it correctly," he added.
At its June meeting, the Fed raised rates to between 1.75% and 2.00% and at least one more increase is expected in 2018, most likely in September.
Bullard is not a voting member of the Federal Open Market Committee; he rotates on as a voting member next year.
Handled properly, the economic expansion, which Bullard characterized as "long and subdued," could be extended further, he said.