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WHEN: TODAY, TUESDAY, SEPTEMBER 24TH
WHERE: CNBC'S "SQUAWK BOX"
Following is the unofficial transcript of a CNBC EXCLUSIVE interview with New York Federal Reserve Bank President William Dudley.
All references must be sourced to CNBC.
STEVE LIESMAN: Bill, thanks for joining us.
WILLIAM DUDLEY: Great to be here.
STEVE LIESMAN: So, let me ask now about after last week's meeting. Can you clearly describe for me what the test is to determine whether or not the Fed would reduce the amount of quantitative easing?
WILLIAM DUDLEY: I can't speak for the committee, but I can speak for myself. In my mind-- beginning to decide to reduce the pace of asset purchases from the current $85 billion pace requires sort of two things in my mind. Number one, improvement in the labor market; and number two, confidence that the economy is strong enough to support that improvement in the future.
STEVE LIESMAN: Is that new? And if it's not new, w-- why is it that the market didn't understand that beforehand?
WILLIAM DUDLEY: I don't think it's new. I think that-- what we did is completely consistent with what the chairman laid out in his June press conference. It's data dependent, depends on how the economy is actually performing. The chairman never said that we were going to reduce the rate of asset purchases in September. He said later this year. I think that framework that he laid out is still very much intact. But we actually have to see 1) improvement in the labor market, and 2) confidence that that improvement's going continue-- in the future.
STEVE LIESMAN: So, if that's not new, then the market should've known that. And it means the market thought that you believe there was improvement in the labor market and-- continued confidence in growth. Or did the market get the assessment of the economy wrong?
WILLIAM DUDLEY: Well, the economy has been a little w-- weaker than we thought at the time of the June meeting. You know, we haven't seen an acceleration in economic activity. I mean, you look at the Fed's forecast, it looks for f-- acceleration in economic activity. The problem is that's still a forecast. And if you look at our projections in September relative to June, you can see that we're actually expecting somewhat slower growth in the second half of 2013 than we were back in June.
STEVE LIESMAN: So, if I can go back, do you have a reason for why people appeared to be surprised by the decision on Wednesday?
WILLIAM DUDLEY: I think my own personal view is that people jump to conclusions. I think we're trying to be very plain speaking, we're trying to be very transparent, but sometimes people think that-- we're hinting at something. So, the chairman talked about the --you know, potential path to beginning to taper.
And people-- and he said later this year was possible if the economy evolves in-- in line with our expectations. And people said, "Oh, he must mean September." But, you know, I don't think-- I think we're trying to be very plain spoken and I think people sometimes exaggerate. They look for sorta hints-- when we're trying to be as transparent as possible.
STEVE LIESMAN: Does it bother you that people misunderstood?
WILLIAM DUDLEY: Well, I mean, I think it'd be better if they understood us better. You know, that's one reason why, you know, we give speeches and that's one reason why we do interviews like this, is to try to communicate as clearly as possible with the market.
STEVE LIESMAN: So, it is possible there wasn't enough communication with markets in the lead-up to the September meeting?
WILLIAM DUDLEY: Well, I think it's hard to communicate if you're not exactly sure h-- you know, what you're going to do at the meeting. I mean, that's one reason why you have the meeting. You know, the data have diverged from our expectations, but only modestly, only a little bit weaker than expected. So, I think at the-- you know, at the time of the September meetings, just seeing-- looking at it from my perspective, not clear exactly where we're gonna end up at that meeting. That's what-- you know, that's what we have the meetings for.
STEVE LIESMAN: Was the decision, in your mind, to maintain the current level of quantitative easing a close call?
WILLIAM DUDLEY: I wouldn't want to characterize whether it was a close call or not. I mean, I think that in my view, 1) we have seen improvement in the labor market. The unemployment rate's come down from 8.1% when we were meeting last September to 7.3% today.
But that decline in the unemployment rate I think overstates the improvement in the labor market. Because 1) we've seen a drop in the participation rate, and when you look at some other measures of-- labor market conditions, they haven't shown the same degree of improvement. One statistic that's an interesting one-- the number of-- of unemployed workers per-- unfilled job right now is three. From 2003 to 2007, it was two. So, if you're unemployed right now, the opportunities to find the job are quite a bit less than they were back in-- before the recession.
STEVE LIESMAN: You repeated the remarks of-- Chairman Bernanke-- from June, saying that a taper was likely to happen later this year. Is that your opinion at this point still?
WILLIAM DUDLEY: I certainly wouldn't want to rule it out. But it depends on the data. I mean, the thing that we really want to emphasize is that it's driven by data, not by time. So, when the chairman said "later this year," that was conditioned on the economy behaving in a way in line with the Fed's forecast. So, if the economy were behaving l-- in a way aligned with the Fed's June forecast, then it's certainly likely that the Fed would begin to taper later this year. But whether that's gonna happen or not remains uncertain.
STEVE LIESMAN: Is there another message here from what happened last Wednesday? Actually, maybe more than one message? Is-- is there another message from what happened last Wednesday, which is, "Don't get too far ahead of the Fed in terms of tryin' to figure out what we're gonna do, which is A) decisions are actually made at meetings, not preordained ahead of time, and B) when we're not sure, then you should not be sure"?
WILLIAM DUDLEY: Well, I guess I would turn that around and just say it depends on the economic information. In other words, are we seeing improvement in the labor market? Is the data that we're seeing consistent with that improvement continuing? That's what you should focus on.
STEVE LIESMAN: I was a little confused by the notion that one of reasons cited by the chairman was tighter financial conditions, you also have cited that, which is higher interest rates. It seems a bit of a circular logic in the sense that you announce you're gonna taper, rates rise, and then you say, "Well, we're not gonna taper because rates have risen." So, therefore, in that logic, you can never get to tapering or reducing your quantitative easing.
WILLIAM DUDLEY: I think it's a question of why financial conditions are rising and is the tightening of financial conditions modest or large relative to your expectations. At the end of the day, we set monetary policy to affect financial conditions and affect the real economy.
So, let's imagine that financial conditions tighten by more than what we anticipate. We wanna take that into consideration in terms of our economic forecast. And I think what happened between May and, you know, prior to this last meeting, the tightening of financial conditions was quite large, especially in terms of the mortgage market.
STEVE LIESMAN: So, does that mean you're sort of targeting in your-- at least in your heads, if not spoken, a range for rates that is acceptable for you in order to eventually move forward?
WILLIAM DUDLEY: No. Absolutely not. I mean, we're looking at growth momentum of the economy. We're looking at how financial conditions are likely to affect that growth momentum going forward. If the economy was really strong and financial conditions tightened, we'd still be pretty confident that the economy was gonna grow more quickly in the future. But if the economy is not that strong and financial conditions are tightening, that's gonna reduce our confidence in the economy growing fast in the future.
STEVE LIESMAN: But part of the reasons why it would appear financial conditions tightened so much was because markets seem to be forever preempting or running ahead of the Federal Reserve-- in the sense that it's going to tighten or-- of bring future interest-rate hikes. So, the markets seem to make-- a decision when the chairman announced the June the possibility of a taper that it meant-- that interest rates would rise more quickly. Is there a way to avoid that in the future?
WILLIAM DUDLEY: Well, I think we-- you know, as I said in my remarks today we want to be very clear that the decision on asset purchases is pretty independent of the decision about actually raising short-term interest rates. We have made it very clear that we didn't-- you know, the-- the conditions for raising short-term interest rates are we would expect the unemployment rate would have to fall below 6.5%, assuming inflation.
The inflation outlook is still, you know, okay and inflation expectations are well anchored. In that case, we're-- we're gonna wait until the unemployment rates fall past 6.5% and that's a threshold, not a trigger. Under certain economic circumstance, we could wait a long time after the unemployment rate falls below 6.5% before we actually-- we have short-term rates.
So, people-- so, people should delink these two choices. The decision on tapering is how m-- fast are we adding accommodation? H-- how much are we increasing our balance sheet? The decision on raising short-term interest rates is a tightening. People shouldn't conflate the two.
STEVE LIESMAN: You keep saying that. You've said that several times and the chairman said that several times. Other members of the – have said that several times. But it doesn't seem like the market is agreeing with that. They seem to think a taper is a tighten. How can you change that? Or is there-- is there-- do you feel like you're making any progress in that regard?
WILLIAM DUDLEY: Well, I can't judge whether we're making progress. But we're gonna obviously keep tryin' to communicate in terms of how we're looking at things. Now, it's true that if we do something that's different than the market expectation-- for example, would follow-- a less-accommodative path than what the market expects, you know, that cause a rise in-- in long-term rates, even though we're still adding accommodations.
So, I think you have to distinguish between a change in market expectations about the path of monetary policy that can drive up short-term rates, as opposed to adding-- you know, adding-- you know, buying assets. That's accommodative, buying assets. If we buy assets at, you know, a lower rate than the $85 billion per month, we actually are still adding accommodation.
STEVE LIESMAN: Is it telling you anything about the effect this of QE in terms of the stock of assets you purchase versus the flow? Some guys say, some analysts say that this shows us that the market is really keyed on the flows, whereas the Fed keeps saying it's the stocks. Are you changing your opinion on that at all?
WILLIAM DUDLEY: No. I think that the stocks are still what r-- really matter. But the decision about whether to taper or not, the market takes that as an independent judgment on monetary policy. So, there's the taper decision, then there's the signal that the Fed has decided to do something differently than it's done in the past. So, the market, I think, views it as, "Okay, if the Fed has changed what they're doing, they must have seen enough information to get them more confident." So, that's-- so-- you can't really separate those two.
STEVE LIESMAN: A couple more questions just in this regard here. You have emphasized, it seems pretty recently – the chairman the notion of actual economic performance as opposed to forward guidance. And I always thought that the key for policy right now was the forward-looking-- forecast, in terms of where you're going. But now, it seems like you have said-- recently that, "It has to be-- show up in the data for me to have confidence."
WILLIAM DUDLEY: Well--
STEVE LIESMAN: Is that a change?
WILLIAM DUDLEY: No. It's not a change. The forecast, obviously, is what's gonna ultimately drive policy. But the question is how confident are you in that forecast? And if you have real data showing that the economy is actually accelerating, that's gonna make you more confident in-- in-- in the forecast for stronger economic growth.
And we've seen in the last few years-- if you go back and look at the Fed forecast, you know, from 2010 onward-- the forecast showed an acceleration in economic activity and-- basically, most of those cases, though, that-- that acceleration of economic activity has not materialized. So, we just can't be overconfident just because we're forecasting something that that won't necessarily materialize.
STEVE LIESMAN: Some would say that's because you overrate the effectiveness of quantitative easing.
WILLIAM DUDLEY: I don't-- I would disagree with that. I mean, I think we've seen in terms of the tightening of financial conditions that occurred from May to now, just on the basis of us reducing the rate of asset purchases, suggest to me that asset purchases have actually had a pretty significant effect in terms of influencing financial market conditions.
STEVE LIESMAN: So, this is interesting of these last two events. June, which was-- the Fed was more hawkish than the market expected, and September where it was more dovish, and the impact on it. Just curious, what have you learned about the effectiveness of quantitative easing from those two events?
WILLIAM DUDLEY: I think, if anything, we've learned that it's actually pretty powerful-- in terms of affecting financial conditions in the economy.
STEVE LIESMAN: Is it more effective than you thought? Is-- is that-- is that the kind of-- response you expected from those two developments?
WILLIAM DUDLEY: I wouldn't try to fine-tune it, Steve, in terms of saying, you know, is-I think-- there's nothing that I've seen that would cause me to change my view of the efficacy costs of-- of quantitative easing, that it's-- that it's actually positive in terms of providing stimulus to the economy.
STEVE LIESMAN: I wanna talk about the change in leadership at the Federal Reserve-- first of all, relative to monetary policy. A change of leadership is coming, and yet the Federal Reserve is heavily involved in forward guidance. Can the market have any-- trust or confidence in that forward guidance, given that there's going to be a change in leadership?
WILLIAM DUDLEY: I think that the market should have reasonable confidence in the forward guidance. Because the reality is the Federal Reserve is not just about the chair. There's a lotta other people-- that participate in the process, the other members of the FOMC and staff.
And there-- and the-- the Fed's mandate is very clear, maximum sustainable employment in the context of price stability. And all these members of the committee are facing the same data set. So, you know, I'd be very surprised if the- if monetary policy were to change its approach on a going-forward basis.
STEVE LIESMAN: Regardless of who the next chairman is?
WILLIAM DUDLEY: Regardless.
STEVE LIESMAN: Do you have a specific candidate who you'd like to see take -- ?
WILLIAM DUDLEY: No. I'm gonna leave that to the-- to the president and to Congress.
STEVE LIESMAN: Janet Yellen is among those who's often-- dis-- mentioned as a potential-- nominee from the-- from President Obama. D-- you've worked with her for a while. What kind of monetary policy might we expect from-- from Janet Yellen?
WILLIAM DUDLEY: I think it'd be very consistent with the monetary policy that we've had in the past. So, I would s-- not see it as any large, you know, change in the monetary policy -- I've known Janet for many, many years. I'm a huge supporter. She's smart. She's tough. I think she'd be a very fine choice, if that's wh-- the p-- where the president decided to go.
STEVE LIESMAN: One of the knocks against her has been that she was not as good as maybe another candidate when it came to crisis management. Is that a fair criticism?
WILLIAM DUDLEY: I'm not gonna get into debating the merits of the different candidates, Steve.
STEVE LIESMAN: Let's talk about-- the issue of-- bank earnings right now. There's a lot of analysts out there that are reducing their earnings or outlooks for banks. What I don't understand about that, and I was hopin' you could help me out with, was isn't that interest margin on the rise for these banks, in terms of their cost of funds being the same? Is that part of what Fed policy is designed to do? And in that, that's part of one of the things that's happening, is it curious to you that lending hasn't picked up more in the economy?
WILLIAM DUDLEY: We're certainly not setting monetary policy with the, you know, eye on what it does to bank earnings. Obviously, when interest rates are very low, the value of core-- retail deposits is less, and that has some negative consequence for banks.
But, you know, when I look at the banking system right now, what I see is a banking system that's built its capital back tremendously. I see a banking system where credit conditions are easing. So, I-- I don't really think the banking system is really an impediment to economic growth in this country.
STEVE LIESMAN: Are you surprised at this point the there hasn't been more of a pickup in bank lending?
WILLIAM DUDLEY: I-- you know, I think it's-- you know there's a -- it's a demand-supply-- effects. I mean, I think credit is-- improving in its availability. I think demand for credit is still, you know, sorta weak because the economic outlook is still uncertain. So, I-- I don't really view that the banking system problems now as-- as-- as weighing on the recovery very much.
STEVE LIESMAN: And one of your concerns is that higher interest rates might really-- curtail housing momentum.
WILLIAM DUDLEY: Well, we've certainly seen a significant backup in-- in mortgage rates since May. Before last week's reversal, it was about 120 basis points rise in mortgage rages, 30-year, fixed-rate mortgage of both 4.5%. And, you know, I you know, I'm not sure what that's gonna do to the housing market.
We don't really have much data yet to be able to judge that effect. It'd be nice to learn a little bit more from the-- from the economy and the inflow of economic information. 'Cause obviously, if the housing market were-- let's just say that the housing market were really hurt by that. That'd be pretty significant in terms of your economic outlook.
STEVE LIESMAN: I have to go back to something you said earlier, where you said-- that it's the level of interest rates relative to the underlying momentum-- of the economy. Is there a level right now that ten year at 285 and the 30-year mortgage above 4%, is there a level that you think is right for the economy?
WILLIAM DUDLEY: We're certainly not trying to target a given level of interest rates. We're trying to set a monetary policy regime that's very accommodative to foster financial conditions that support economic recovery in the United States.
STEVE LIESMAN: Let me-- let me go back to another concern that's out there about monetary policy, which is regulation. This notion that a Volcker rule, which makes it difficult for banks to provide liquidity to the treasury market or to other-- parts of the fixed-income market, really works against the Fed in its attempt to transmit monetary policy. Do you have concern about that?
WILLIAM DUDLEY: I think from my perspective, I don't have much concern about that. I mean, it's true that-- to the extents that-- you know, the dealer's balance sheets are smaller and maybe they have less capacity to absorb inventory during, you know, times-- when there's a lot of turbulence in the market. Maybe it could increase short-term volatility and asset prices a little bit. But I don't think it has any meaningful, longer-term impact. I think the impact on the macro economy is de minimis.
STEVE LIESMAN: Is that true now? Do you have concerns about the future when-- when the Volcker is actually implemented?
WILLIAM DUDLEY: Well, I'm not gonna talk about the Volcker rule 'cause it's still s-- still in the process of-- of being developed. I think that at the end of the day, you know, the-- the changes that we've made in the regulatory regime in the U.S.-- are fully consistent with having a sustainable economic recovery.
STEVE LIESMAN: Okay. One area where you said, suggested that there has not been enough regulatory progress is in-- money markets and-- and derivatives. Are-- are you-- do you have real concerns right now about the-- stability of the financial system because of the lack of regulation for money markets?
WILLIAM DUDLEY: Well, I think that we still have a vulnerability there. The vulnerability is less because if you remember what happened the last time around-- it was-- it was triggered by the failure of a large-- financial institution. So, to the extent that we've made our fin-- large financial institutions more secure than the-- than the risk of a money market fund is diminished.
But I am concerned because when-- you know, the-- down the road, there is-- there is always the risk that you could have a f-- a failure of a large systemic really important firm again. And to the extent that money market funds would have exposure to those firms, then they could be-- in-- in difficulty again. And in some ways, the problem is a little bit greater than it was during the financial crisis because the ability of the treasury to guarantee money market fund assets was taken away by the-- the-- the Dodd-Frank Act.
STEVE LIESMAN: Could you give us the 30-second version of what regulation you'd like to see placed on money markets-- in order to remove that concern about stability?
WILLIAM DUDLEY: I don't think I could do it justice in-- in 30 seconds. I-- I think what we really wanna do, though, is make it so that money market funds are less subject to run risk. What we saw in the-- in the financial crisis after Lehman's failure was that people were pulling their money out of money market funds very quickly.
And one of the reasons that they had incentives to pull their money out-- was the fact that we have a a system of-- a fixed net-asset value. So, if you get your money quickly, you can get out at the net-asset value. And I think that-- that-- that's one element of money market fund reform, I think, that needs to be carefully considered.
STEVE LIESMAN: What is your-- outlook right now for what's going on in Washington in terms of the debate over the continued resolution and the debate over the debt ceiling? Do you think it's gonna be worse than last time, and will the economic effect be worse than last time?
WILLIAM DUDLEY: I don't know how it's gonna be resolved. But I do agree it's-- it's trading at a high level of uncertainty and I think people are worried about the possibility of-- of a bad outcome. So, it does create a little bit of a cloud right now over the economy. And you-- you can certainly imagine that that can cause businesses and households to hold off on their spending positions. So, even with a good outcome-- it could actually have a negative effect for the economy over the near term.
STEVE LIESMAN: Is that one of the areas that, when you got a when you get a little clarity on that, it would make you m-- clear the way for reducing the amount of quantitative easing in the economy?
WILLIAM DUDLEY: I think clarity there – clarity is-- it's resolved in a reasonable way. I think that would remove one potential obstacle.
STEVE LIESMAN: What-- what's the message you'd like to send to Congress right now as a monetary policy maker trying to help the economy? What would you like to say to them about-- what they should do with fiscal policy?
WILLIAM DUDLEY: I'm not gonna tell them how they should conduct fiscal policy. But I think less drama, more certainty would be a very good thing.
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