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WHEN: Today, Thursday, February 14, 2018
WHERE: CNBC's "Squawk on the Street" – Live from the Federal Reserve in Washington D.C.
The following is the unofficial transcript of a CNBC EXCLUSIVE interview with Federal Reserve Governor Lael Brainard and CNBC's Steve Liesman on CNBC's "Squawk on the Street" (M-F 9AM – 11AM) today Thursday, February 14th. The following is a link to video from the interview on CNBC.com: https://www.cnbc.com/video/2019/02/14/watch-cnbcs-full-interview-with-federal-reserve-governor-lael-brainard.html.
All references must be sourced to CNBC.
STEVE LIESMAN: David, thanks very much. I'm here inside the Federal Reserve, and we are live with Federal Reserve Governor Lael Brainard. Thanks for joining us, Governor Brainard.
LAEL BRAINARD: Thank you.
STEVE LIESMAN: Great. So, let's talk about this retail sales number this morning, disappointed, it turned the market around. Does it cause concern for you to see a number like that being negative with the lowest number in nine years?
LAEL BRAINARD: Certainly caught my eye. Certainly caught my eye. It's a miss. It is one month of data, so, you know, don't want to take too much signal from it, but certainly adds to a story where we want to take on board that there's downside risks. At the same time we're still getting pretty good numbers, more recent numbers on payrolls.
STEVE LIESMAN: How does it fit in with your general view of the economy? Did you believe the economy is decelerating? Is that part of that framework that you have?
LAEL BRAINARD: So I think going into this year we would have expected a solid growth figure, but a slower growth figure than the very strong growth we were getting last year. But downside risks have definitely increased relative to that modal outlook of continued solid growth.
STEVE LIESMAN: Let's talk about some of those risks that are out there. First overall question: do you see an elevated risk of recession this year or next?
LAEL BRAINARD: I would certainly say there are a variety of downside risks. And, of course, I'm very attend I have to all the recession indicators that people look at, including the slope of the yield curve. But in terms of the other kinds of downside risks, foreign growth has slowed. It was first very apparent in China, but now we're seeing those numbers coming in below expectations in Europe. Policy uncertainty still high whether, you know, we look at trade conflict with China or whether we look at Brexit, and financial conditions have tightened, so I want to take those on board as I think about the year ahead.
STEVE LIESMAN: You have a lot of international experience at the Treasury and also at the Federal Reserve. Have you been concerned about the ability or the possibility that global weakness will come and hurt the U.S.? What's the sort of level of concern with that?
LAEL BRAINARD: Yeah. So we are a very international economy. Our financial system in particular has shown itself to be very responsive to earnings abroad, to financial conditions, volatility abroad. So, yeah, I'm very attentive to the international outlook. Now, the truth is that our underlying domestic momentum has been pretty soiled and that's been the driver for the U.S. economy. But when we see financial conditions tightening abroad and a big downdraft on growth abroad, yeah, we need to take that on board here.
STEVE LIESMAN: These past several months have been one of the bigger shifts that I've noticed in following the Federal Reserve. You, in September, talked about rates going up over the next two years. In December, the Federal Reserve raised rates. And now you're in this patient mode, and the market is actually expecting a rate cut. Did you guys make a mistake or miss something in the lead-up to where you are right now?
LAEL BRAINARD: Yeah. So back in December, I already noted that cross currents were increasing and that tailwinds were dying down. And I think that is even more true today because of those downside risks that are gathering. I think we are in a good place today. I'm comfortable waiting and learning. We want to see the data as it comes in. But, you know, I think in terms of the – let's be on hold for now while we learn about what's going on in the economy, I think it's the right place to be.
STEVE LIESMAN: So if I'm a guy in the market, or a woman in the market, I have to put a number on hold for now. Does that mean I should not expect any rate hikes this year?
LAEL BRAINARD: Well, so, let's go back to the outlook. The outlook is generally -- the modal outlook is generally for solid growth, and the labor market continues to serve of up numbers that have supported that. But the risks to the downside have grown, and so I think we'll have to wait and see what the right move, if any later in the year is. But right now, I think we're in a very good place to watch and see that data as it comes in.
STEVE LIESMAN: Would you say there are equal odds it could go either way the next policy move?
LAEL BRAINARD: So I wouldn't want to assign odds, but I'd certainly say that where I am today with a kind of hold and carefully monitor incoming data is a very appropriate place.
STEVE LIESMAN: Let's talk about the balance sheets. Should the balance sheets be sensitive to the economic outlook?
LAEL BRAINARD: So I think on the balance sheet, it's really important to distinguish between the overall technical factors and monetary policy. With regard to just the general size of our balance sheet, ultimately, you know, we said last time that we're going to stay in an ample reserve system. My own view is that balance sheet normalization process should probably come to an end later this year. We know that liquidity demand on the part of financial institutions is much higher than it was pre-crisis so we want to make sure that there's an ample supply of reserves to guard against volatility. That's a separate question from what the committee clarified in our last statement, which is the balance sheet will always be consistent with our dual mandate goals, with the policy rate being the active policy instrument, but we wouldn't want those two instruments to be work at cross-purposes.
STEVE LIESMAN: Sure. When you say come to the end sometime this year, do you have a place where you feel comfortable talking about going to with the size of the balance sheet?
LAEL BRAINARD: So, you know, my own view is that we want to have an ample supply of reserves. We've taken some soundings of the market in terms of what that demand for reserves, is. And I would want to have a substantial buffer on top of that to avoid volatility. So in my view that balance sheet normalization process probably should come to an end later this year. But, you know, it's important to remember we've already seen a very large amount of normalization taking place. Reserves are down 40% from their peak. They will be down more than 50% later in the year. So for me it seems that the balance sheet normalization process has – has really done the work it was supposed to do.
STEVE LIESMAN: I don't think I do math in trillions live on television all that well, but if I'm not mistaken coming to an end sometime later this year would likely leave you north of $3.5 trillion.
LAEL BRAINARD: So I think really in terms of reserve demands and, you know, again, we did a survey back in August, and, you know, my own sense is we want to have a comfortable buffer on top that have.
STEVE LIESMAN: Okay. I want to just ask you about overall monetary policy and the changing world we live in right now. Have you been surprised, given the strength of the U.S. economy in 2018, by the absence of inflation? And are you now ready to maybe change your framework to let inflation – sorry, let GDP run a little hotter and wait until the inflation comes up, rather than anticipating it?
LAEL BRAINARD: Yeah, so I think for several years now, I have been very, sort of focused on the fact that we're in a new normal with a low neutral rate and with much less of a kind of Phillips Curve framework. We're just not seeing that transmission from the labor market to inflation. We are now seeing inflation coming in around target. Our CPI read yesterday was encouraging in that respect. And I'm going to want to see, you know, a strong labor market and continue to support inflation coming in around target.
STEVE LIESMAN: Does that mean you would countenance, I guess is the best way to put it, as a Federal Reserve policy-maker a lower inflation rate than -- I mean, would 3% make you real concerned when it came to the unemployment rate?
LAEL BRAINARD: So what I'll be looking at is both the labor market and labor force participation and the ability of the labor market to pull more people into productive work, as well as that inflation trajectory. And, you know, again, I think were -- we've had many years where we were below our target and so right now, the real focus is making sure that we stay at target, make sure that we are at that 2% in a world where a lot of other countries are well below their target and have been for a long time.
STEVE LIESMAN: I just have one more question. We set up all this equipment and I know have you a couple of extra minutes here. And you're so involved in the financial regulatory world, and it's very hard to have all the time to get into all the details, but when it comes to lowering the liquidity buffer for banks between $200 and $750 billion, when it comes to giving banks more information on the stress test, do you have concern that we're rolling back the regulations that came in the post-crisis period too quickly and too much?
LAEL BRAINARD: Yeah. I have been and remain strongly in favor of reducing burden on our community banks. They are such an important part of the banking landscape, and I don't think some of the post-crisis regulations are appropriate for them. But for the large banks, for the 250 plus banks or the large and complex banks that have trading operations, I think it is very important to make sure we safeguard those liquidity buffers they've built, safeguard those capital buffers they've built. The stress test is an incredibly useful tool. We don't want to give the test questions ahead of time. We want to retain that stress test framework as a valuable tool for making sure capital buffers are resilient.
STEVE LIESMAN: Lael Brainard, Federal Reserve Governor, thank you for joining us.
LAEL BRAINARD: Thank you.
STEVE LIESMAN: Live from the Federal Reserve, back to you guys.
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