US Fed dove mulls negative rates in market calming speech


US Federal Reserve governor Lael Brainard has said negative interest rates “merit further assessment” and warned the central bank needs to act with “prudence” over rate hikes in comments that calmed markets.

The S&P clocked 1.5 per cent, its biggest rise in two months, almost recouping its 2.45 per cent fall on Friday, following considerably more hawkish comments from other US Fed officials.

The FTSE 100 followed US markets when it opened on Monday, down 1.5 per cent within hours of opening.

Brainard, who is considered among the most dovish members of the FOMC, said as interest rates neared the negative bound raising the inflation target, moving to a nominal income target, or deploying negative interest rates were all options for reacting to an adverse shock.

“These options merit further assessment. However, they are largely untested and would take some time to assess and prepare,” Brainard told the Chicago Council on Global Affairs.

It is not the first time Brainard has raised the issue, arguing last October the Fed would “benefit from studying and learning about” Europe’s experience with negative rates. Despite her dovish tone then, the Fed raised rates two months later.

In yesterday’s speech, Brainard raised concerns that the Bank had ample policy space to react to “unexpected strength”, but that in the face of an adverse shock the Fed’s “conventional policy toolkit is more limited”.

“This asymmetry in risk management in today’s new normal counsels prudence in the removal of policy accommodation.

Brainard, who is rumoured to be Hilary Clinton’s pick for Treasury Secretary, says as labour market slack diminishes upward pressure on inflation should result, as demonstrated by the Phillips Curve, but this has not eventuated in the post-crisis economy.

“To the extent that the effect on inflation of further gradual tightening in labour market conditions is likely to be moderate and gradual, the case to tighten policy preemptively is less compelling,” Brainard said.

In the labour market, Brainard raised concerns about high part-time employment levels, low prime-age labour participation rates, and a muted recovery in wage growth.

Brainard points to research that suggests US monetary policy leads to exchange rate movements that are “several times bigger than they were several years ago”. Likewise adverse foreign demand shocks have a “particularly strong” effect on the value of the dollar due to it being a favoured safe-haven asset.

Brexit and China’s transition to a consumer economy were listed as causes for concern in a global economy that is more interconnected than ever before.

In Europe and Japan, Brainard raised concerns that inflation remained below target levels despite “active and creative monetary policies”.

Ten years ago, based on the underlying economic relationships that prevailed at the time, it would have seemed inconceivable that real activity and inflation would be so subdued given the stance of monetary policy.

Despite taking a dovish tone throughout her speech, Brainard pointed to signs of positivity in the US economy. “The labor market has continued to improve, consumer confidence has remained high, and we have navigated past near-term risks from abroad.”