MNI: Fed Rates Headed To Neutral 'Over Time' - Williams

It will become appropriate to lower U.S. interest rates to a "more neutral setting over time" as the labor market is gradually cooling to pre-pandemic levels and inflation has remained above the Fed's 2% target, New York Fed President John Williams said Thursday.

"Looking ahead, if progress on our dual mandate goals continues as in my baseline forecast, I anticipate it will become appropriate to move interest rates toward a more neutral stance over time. This expectation reflects a delicate balancing of risks to our mandate goals," he said in prepared remarks. 

"On the one hand, we need to keep the labor market in balance to ensure that the effects of tariffs do not spill over into a longer-lasting broad increase in inflation. On the other hand, maintaining a stance of 'too restrictive policy for too long' could increase risks to our maximum employment mandate," Williams, the FOMC vice chair said. 

The combined effects of trade and immigration policies and associated uncertainty will continue to weigh on growth, which he forecasts to be 1.25% and 1.5% this year, he added. He expects unemployment to gradually rise to 4.5% next year and headline PCE inflation to land between 3% and 3.25% this year before falling to around 2.5% next year and reaching 2% in 2027, he said. (See: MNI POLICY: Fed Takes Measured Approach To Post-September Cuts) 

GRADUAL COOLING 

Williams told the Economic Club of New York that the totality of the data over the last year shows a gradual cooling in labor market conditions to levels similar to those that prevailed in the years prior to the pandemic.

"First, the labor market is currently in balance and not adding to inflationary pressures. Second, the gradual cooling in the labor market is consistent with the slowing in overall economic growth and my assessment of monetary policy being modestly restrictive," Williams said. 

"Third, as we are seeing today, when there are sharp changes in labor supply, it can be challenging to assess the rate of job growth consistent with that of labor supply. I therefore put greater weight on other indicators of the level of labor market conditions in assessing the strength of the labor market." 

TARIFFS' IMPACT 

The realized aggregate effects of tariffs so far have not been as large as expected earlier in the year, but it’s still early days, Williams said. 

"There are clear signs that tariff increases are affecting consumer prices and that trade diversion is taking place," he said. All in all, I expect tariffs will boost overall prices by a total of between 1 and 1.5%, with these effects continuing through the first half of next year." 

Williams noted he is not seeing amplification or second-round effects of tariffs on broader inflation trends, and longer-run inflation expectations have remained stable, while short- and medium-term inflation expectations have returned to their pre-pandemic ranges. 

It will take time for tariffs to come to be fully realized in inflation. "Combining enacted and announced tariffs, estimates of the average effective tariff rate range between 15 and 20%. By comparison, net tariff receipts as a share of imports rose from about 2.25% in the first three months of the year to around 10% in July."

BALANCE SHEET

The New York Fed president also said the central bank's QT program is "going very smoothly." 

"With take-up at the overnight reverse repo facility now quite low, the level of reserves has already started to decline and is expected to decline more meaningfully going forward as our asset holdings continue to shrink and other liabilities rise," he said. "We continue to closely monitor a range of indicators related to the ampleness of reserves."