Brainard Says Recent Bond Market Moves Have ‘Caught’ Her Eye

(Bloomberg) -- Federal Reserve Governor Lael Brainard said it will take “some time” to meet the conditions for economic progress laid out by the U.S. central bank for reducing the pace of its massive asset purchases, while noting recent bond market volatility could cause further delay.

“I am paying close attention to market developments,” she said Tuesday in response to a question after giving a speech. “Some of those moves last week, and the speed of the moves, caught my eye,” she said, adding that she would be concerned if she saw disorderly conditions, or persistent tightening in financial conditions, that could stall out the economy's gains toward maximum employment and sustained 2% inflation.

The sharp rise in 10-year Treasury yields has provoked speculation that the central bank might take steps to prevent this from undermining the recovery, including by shifting its bond purchases to longer-maturity securities.

Read More: Treasury Curve Dysfunction Ignites Talk of Federal Reserve Twist

“This is the first Fed official who has acknowledged” that the rise in bonds yields “isn't all for good reasons,” said Priya Misra, global head of interest rate strategy at TD Securities, noting that it contrasted with Chair Jerome Powell's view that bond markets were signalling confidence in the recovery. “If there is a quick tightening in financial conditions, the Fed is telling you they are willing to act and prevent it from getting worse,” Misra added.

Powell is scheduled to discuss the economic outlook Thursday and can expect to be asked if the spike in 10-year Treasury yields last week to the highest level in a year warrants a Fed response.

In her virtual speech to the Council on Foreign Relations, Brainard acknowledged the economic outlook has perked up but repeatedly stressed that risks remained.

‘Strong' Outlook

“Increasing vaccinations, along with enacted and expected fiscal measures and accommodative monetary policy, point to a strong modal outlook for 2021,” Brainard said, while noting that “considerable” uncertainty remains around any forecast.

“Today the economy remains far from our goals in terms of both employment and inflation, and it will take some time to achieve substantial further progress,” she said, referring to the criteria that policy makers have set for adjusting asset purchases.

U.S. central bankers are buying $120 billion in U.S. Treasuries and mortgage-backed securities a month in an effort to keep longer-run interest rates low. They have also signaled they expect to hold interest rates near zero at least through 2023 to help the economy through the Covid-19 pandemic.

“Even after the conditions for liftoff have been met, changes in that policy rate are likely to be only gradual,” Brainard said during the question and answer session.

Economists have marked up their GDP forecasts to around 5% for this year, on the expectation that some form of additional fiscal stimulus gets signed into law, while firms such as Deutsche Bank said the unemployment rate could fall to the 4% range by year end. The robust forecasts depend on wide-spread vaccination and consumers dropping their caution and immediately going back to old spending habits.

‘Significant Boost'

Brainard didn't rule out that scenario. “Additional fiscal support is likely to provide a significant boost to spending when vaccinations are sufficiently widespread to support a full reopening of in-person services,” she said.

A surge in spending as people resume activities, combined with fiscal support, could lift prices temporarily.

“A burst of transitory inflation seems more probable than a durable shift above target in the inflation trend and an unmooring of inflation expectations to the upside,” Brainard said.

The Fed governor noted that the fraction of working-age women who left the labor force for care-giving had increased by 2.4 percentage points.

“If not soon reversed, the decline in the participation rate for prime‑age women could have scarring effects, with longer-term implications for household incomes and potential growth,” she said.

©2021 Bloomberg L.P.