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Bullard says US inflation is 'worrisome' and markets are wrong on Fed rate path

James Bullard
Mike Mergen | Bloomberg | Getty Images
James Bullard

Federal Reserve (Fed) policymaker James Bullard has declared that the path of inflation in the U.S. is "worrisome", speaking in Tokyo on Friday.

The U.S. central bank's plan for raising interest rates in the coming years is also too aggressive, asserted the St. Louis Fed president, whose dovish views are well-known.

The comments caused a minor rally in U.S. Treasury bonds with the yield on 10-year securities dropping by around 1 basis point to 2.24 percent and causing a mild flattening of the yield curve.

Bullard drew attention to the current level of U.S. prices, noting the gap between where they now stand and where he says they should be if the Fed had been able to deliver on its 2 percent inflation target in recent years.

The policymaker – who isn't currently a voting member of FOMC (Federal Open Market Committee) - claimed that U.S. prices now fall 4.6 percent short of the price level path established between 1995 and 2012, when inflation was accelerating at a pace closer to the Fed's annual target.

"This is not as severe as the 1990s Japanese experience, but it is worrisome," said Bullard, who delivered a prepared speech at Keio University and then subsequently spoke informally with reporters.

Turning to the Fed's rate hike plans, Bullard reiterated his long-standing view that the U.S. central bank is seeking to hike rates too quickly and by too much. He also posited that the financial markets' view of the upcoming rate hike trajectory is currently out of lockstep with that of the Fed.

According to the policymaker, financial asset valuations since the last rate hike in March show the Fed's "contemplated policy rate path is overly aggressive relative to actual incoming data on U.S. macroeconomic performance."

Bullard also said that growing expectations that the Fed will begin to pare down its balance sheet was not a concern to financial markets and indeed a process that he looks forward to getting underway in the second half of this year.

Fed futures are currently pricing in around a 65 percent chance of a rate hike in June, according to Neil Dwane, global strategist at Allianz Global Investors, who says that he believes the Fed will raise rates at least three times this year. The CME Group's FedWatch tool currently shows market expectations for a June rate hike are at 87.7 percent.

"The markets are quite relaxed about the fact that the Fed is raising rates and the speed at which they are going to raise rates," he said, noting that when the market gives the central bank a pass like this to raise rates they must take it.

"The way the yield curves are moving, the availability of credit inside the economy. It doesn't feel to us like the monetary conditions are tightening," Dwane observed, interpreting this as Wall Street's message to the Fed that it can handle a tightening of central bank policy by imposing its own offsetting loosening measures.

While the economy may be duller than many had hoped for so far this year, "they have started so they will finish – and they will take every opportunity they can to raise rates," he added, opining that he would expect the Fed to potentially raise rates in August and November should the U.S. economy continue to "bounce" during this quarter and the next.

One more consideration, added Dwane, is the currency markets.

"The weaker dollar means the rest of the world is slightly less under threat so therefore the Fed can raise rates and to some extent manage the strength of the dollar as well."

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