Federal Reserve Bank of Dallas President Robert Kaplan told Bloomberg’s Michael McKee that the stock market swings may not reflect the underlying economy, and officials shouldn’t overreact.
On Bloomberg TV’s “Bloomberg <GO>” this morning, Kaplan said: “This has been a very tough start to the year. It says a lot though about the turmoil in the markets in China….You’ve got to watch these market moves, but you’ve got to realize that they may or may not reflect what’s going on with the underlying economy in the United States. I’d say you’ve got to watch it, and understand it. But not over read or over react.”
On what factors will determine the appropriate time to move interest rates again, Kaplan said: “I would have a bias to want to move toward normalization. I’m sensitive to is running zero interest rates or near zero interest rates as we have is not free. There is a cost to it…It comes with some risk. Every time we increase the federal funds rate, we’re going to have to watch and see what the impact is.”
Kaplan doesn’t consider himself a hawk or dove but sees himself as a “centrist”: “I’d probably consider myself as a businessperson as a centrist. And what do I mean by centrist? It means I’m quite open to looking at new information and changing my mind. I don’t rate unemployment versus inflation. I rate the risks of those and the importance of those about equally.”
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Highlights from Kaplan include:
- Kaplan: Markets are going to go up and down, tough 2016 start
- Have to watch these moves, may not reflect economy
- Officials can’t overreact to market moves
- Job numbers helped bolster confidence in economy
- Non-us growth forecasts are sluggish
- US, world need to adjust to slower china growth
- He sees himself as a centrist
- 2016 US growth to be about 2%-2.5%
- US jobless rate can go lower w/o inflation
- He’s looking at jobless rate, evidence on inflation
- Sensitive to costs of running zero rates
- Has a bias toward normalizing policy
- US fed policy on normal footing ‘if we can’
- Wants to see evidence on inflation next 2-3 years
- Too soon say if four rate rises justified this year
- 3-4 2016 rate rises is ‘reasonable base case’ for fed
Fed’s Robert Kaplan: I’m Centrist Over Hawkish or Dovish View
Robert Kaplan: Looking at Path of Unemployment, GDP
Robert Kaplan: Markets May or May Not Reflect Underlying Economy
MICHAEL MCKEE: Good morning to everyone who is watching and listening to us across all of Bloomberg’s platforms. We are in Dallas where the temperature is 60 degrees.
Robert Kaplan was a Harvard University professor until September of last year, driven out by the terrible winter in Boston last year.
Robert Kaplan: Right.
MCKEE: And we find him now as the new president of the Dallas Federal Reserve, and we thank you for joining us –
Robert Kaplan: Good to be here.
MCKEE: – this morning. A lot of market volatility –
Robert Kaplan: Yes.
MCKEE: – to start the year. What implications do you see from that for monetary policy?
Robert Kaplan: Well, having spent a career – I was before – being at Harvard, at Goldman Sachs, and investment banking for 23 years, the markets are going to go up and down. This has been a very tough start to the year. It says a lot though about the turmoil in the markets in China, which were reflective of their underlying issues.
It also says a lot about our companies in the United States. While exports may be less than 20 percent and manufacturing is less than 20 percent of the U.S. economy, it is a much higher percentage of the profitability of the S&P 500.
So when you see weakness, particularly weakness outside the United States, in China and emerging market economies, it affects our companies. It affects their profitability. It affects the market to a greater degree than it might affect the underlying economy.
So as a monetary policymaker, you’ve got to watch these market moves. But you’ve got to realize that they may or may not reflect what is going on in the underlying economy in the United States. Or, better yet, they can go down for two weeks, and then they can rebound as they did in August and September, and the underlying fundamentals are still strong.
So I’d say you’ve got to watch it, and understand it. But not over read or over react. It takes time to figure out what the market may be saying to us.
MCKEE: Well, Friday, the government reported almost 300,000 jobs were created in December. Monday, the markets tanked. Does it worry you when investors don’t react positively to good news?
Robert Kaplan: No, I think – listen, investors and the market are reacting to corporate profits and expectation of corporate profits. And I’m very mindful of that. Corporate profits actually in 2015 were down in the S&P. There hasn’t been a lot said about that, but they actually declined.
And in the first couple weeks of the year and the end of last year, some of the estimates for corporate profits for 2016 have been revised somewhat down. Again, it is as much or more reflective of prospects around the world as it is about the health of the U.S. economy.
So I’m not surprised that the markets are going to pay attention to other things. I think the job numbers helped. It helped bolster confidence in the U.S. economy. And we’ll have to see over a period of time.
The markets may not react to information in a day or in a week. But over a period of time, they normally weigh all this information. And I think you will see a strong U.S. economy reflected.
MCKEE: Well, what are the prospects for the rest of the world, and particularly for China and their likely impact in 2016 on the U.S. economy?
Robert Kaplan: So the forecast for growth outside of the United States I would call sluggish. And they’re going to improve a little bit in 2016, but it’s very uneven.
So, for example, any country like Venezuela, Brazil, Russia, that are exposed to commodities are actually in recession. And that is probably going to continue in 2016. India is a bright spot.
China, on the other hand, is dealing with a number of issues that are not cyclical. They’re going to take years to deal with. Overcapacity in their industries, over leverage, aging population, and this transition they’re trying to make from an export driven economy to a service sector, consumer economy, that’s going to take many, many years.
So I think the U.S. and the world is going to have to get used to lower rates of Chinese growth, and I think the world is adjusting to that. But it has implications for commodity prices. It will have some implications for U.S. GDP. It definitely has implications for U.S. domiciled companies who are trying to do business around the world. So I think the world and companies and the markets are trying to adjust to all that.
MCKEE: Robert Kaplan was very well known at Goldman Sachs and at Harvard. But as a policymaker, people don’t know where you are necessarily coming from. Which you characterize yourself as a hawk or a dove?
Robert Kaplan: It may be too soon to say. I’d probably consider myself as a businessperson as a centrist. And what do I mean by centrist? It means I’m quite open to looking at new information and changing my mind. I don’t rate unemployment versus inflation. I rate the risks of those and the importance of those about equally.
But I don’t come in with a preconceived point of view as a hawk or a dove. I’m probably a person who is more focused on diagnosis, what to do, and how to do it. And I’m more practical. So probably at this point, I’d call myself a centrist.
I think you’ll see me at times advocating positions that sound a little hawkish. And you may see me at times, depending on the facts and what my analysis is, advocate positions that seem a little dovish. I think I’ll probably be seen as a centrist.
MCKEE: Well, right now, when you look at the U.S. economy, do you worry more about the prospect of inflation accelerating or growth slowing?
Robert Kaplan: Well, I still believe GDP growth in 2016 – our best judgment still is it’s going to be about two percent, 2.5 percent, not great by historical standards, but enough to continue to generate jobs and probably drive down the rate of unemployment.
And so we think we’re making good progress toward reaching our full employment objective in the United States. But I think full employment is going to require rates of headline unemployment below five percent. I think there is more slack than we’re used to at this headline rate of unemployment.
Inflation, on the other hand as you know, has been stubbornly low. And we’re – I think there are some transitory factors, oil being one, the dollar being another, that are driving it down. Our own view in Dallas, we look at this, as you know, this Dallas trend meme would suggest inflation – core inflation is running about 1.6 percent.
But I will be watching that very closely to see if there is evidence of inflation picking up. My suspicion is we’ll be able to run and should be able to run at lower rates of unemployment without sparking as much inflation as we would have in the past. And I think that’s because of globalization and a number of other factors. So those are all things that I’m looking at though.
MCKEE: Well, how low do you think unemployment can go before we see inflation accelerate?
Robert Kaplan: Well, I don’t know the answer to that. But my own sense is I think we can go lower than where we are now. Whether that means 4.5 percent or lower, I think we’re in – the world is different enough. And I gave a talk the other day and you and I talked about it a little bit, the world is different enough than it was even pre-recession, again, because of globalization, much more disruption, aging demographics in the United States and around the world, as well as high levels of debt. And many countries are needing to deleverage.
When you wrap all that up together, I think all that is putting downward pressure on inflation. So this is one of the things I keep asking – I’ll keep asking that question. I don’t think I know the answer.
MCKEE: Robert Kaplan is the new president of the Federal Reserve Bank of Dallas. He took office in September, and he is nice enough to sit down with us here on Bloomberg Radio and Bloomberg Television, and streaming on Bloomberg.com, all of our platforms. He will be back with me for another segment in just a moment here on Bloomberg.
KEENE: Michael McKee, thanks so much. Greatly appreciate that.
MCKEE: Welcome back. We are live on Bloomberg Radio, Bloomberg Television, and streaming live on Bloomberg.com across all of our platforms with the Dallas Federal Reserve Bank President Robert Kaplan.
You are new to the Fed. What is your reaction function going to be? What is going to determine for you when it’s the appropriate time to move interest rates again?
Robert Kaplan: Well, so being new to the Fed, I’ve now been to three FOMC meetings, I’ll do my fourth in January. I’ve gotten a much better feeling – gotten into the bank president, gotten into the governors a much better feeling to understand how the process works. And I’ve spent an enormous amount of time in this district and with our economics team here and economists throughout our system.
And so the main things I’m looking at are unemployment, the path of unemployment, the path of GDP, and again, evidence that we’re moving towards meeting our two percent inflation target. And so those are the factors I’ll be watching regularly.
And so in thinking about the path of normalization, another thing I’m sensitive to is running zero interest rates or near zero interest rates as we have is not free. There is a cost to it. It creates distortions in investment hiring and it creates other imbalances. So I’ll be looking for those also.
But I’m going to be looking at GDP, unemployment, inflation, and trying to understand what is going on around the world and what the future looks like. But I have a bias towards thinking that if we can normalize, it would be much better to normalize because we’ve gotten so used to these potential distortions I don’t even think we recognize them anymore. And I’m sensitive to the fact that we want to get on a more normal footing if we can.
MCKEE: Well, do you have numerical targets for these metrics?
Robert Kaplan: Well, sure. For GDP, basically I want to see that in 2016, for example, we’re going to be between two percent and 2.5 percent. That’s our forecast.
I want to see the unemployment rate continue to drop down. Our own view here is it takes about 100,000 to 150,000 jobs a month to keep the unemployment rate constant. I’d like to see monthly job growth be on that level.
And I do want to see some evidence – we’ll be looking for it – that after some of these transitory factors have passed with oil and the dollar that we’re gradually moving towards reaching our two percent inflation target. Not this year, but over the next two or three years.
So those are things I’m going to be looking for. And, in addition, we’re going to be looking at economic activity all over the world and how it might affect what is going on here.
MCKEE: Do you think that those metrics will justify the four rate increases that the Fed’s SEP suggests would come this year?
Robert Kaplan: Too soon to say. In September – or excuse me, in December, you’re referring to all the projections we made. I think if I thought we were making progress on all those indices that I just talked about, then I think that three or four, something in there, is a reasonable base case.
But the economy never unfolds quite as you expect. And so we’re going to have to just assess conditions and adapt to it. But I think if we saw progress along those fronts, for me, I would have a bias to want to move towards normalization understanding there is always going to be a lot of push back and a lot of resistance to doing that because it comes with some risk.
Every time we increase the Fed funds rate, we’re going to need to watch and see what the impact is. A lot has been discussed about capital flows moving away from emerging market economies because what we’re doing strengthened the dollar, impact on our exporters. So we’re going to have to watch and learn as we act. And I’m going to be very focused on doing that, not predetermine – predetermine what we’re going to do or be too Calvinistic about it.
MCKEE: Speaking of the economy not unfolding as somebody might have predicted, you’re in the middle of the oil patch.
Robert Kaplan: Yes.
MCKEE: Nobody thought we’d see oil around $30 a barrel. What is the impact?
Robert Kaplan: The impact on this state – I think the mayor, who you just interviewed, talked about the fact Dallas has been very resilient, Austin has been very resilient, Houston is much more negatively affected. But the net impact of all this statewide is that job growth is still up in the state, which is a testament to the resilience of the state of Texas, a much more diversified state. But it is still much lower job growth than we had seen in 2014.
To give you some numbers, job growth here was about 3.6 percent in 2014. It was about 1.25 percent, 1.3 percent this year. And we think it’s going to be about the same in 2016. So it has slowed job growth.
MCKEE: Well, we have had an impact on job growth nationwide.
Robert Kaplan: Yes.
MCKEE: And also on CapEx.
Robert Kaplan: Yes.
MCKEE: Are there other areas that you worry about?
Robert Kaplan: Well, so there are two impacts of lower oil prices. One is the media effect of cuts in capital spending, and that is hurting – we’re seeing that in companies. We’re seeing it in the state.
But there is the positive effect of lower prices for consumers, more driving activity. Better car sales most likely because of that, a greater ability to spend on other things.
But I do worry about the ripple effects of what is going on in the energy sector. For example, one of them is energy is a material part of the high yield sector. High yield issuance in the last five years has gone up dramatically. And what happens because the high yield bonds are held in mutual fund now today in ETF form is you have a weakness in one sector, it tends to cause selling in every other high yield sector because of fear of redemptions and actual redemptions.
And so I do worry that some of the things that are going on in the energy sector are making it harder for companies that are leveraged to borrow, and it will widen credit spreads. And it having that effect already.
MCKEE: Robert Kaplan is the president of the Federal Reserve Bank of Dallas. We are going to come back with President Kaplan on Bloomberg Radio in just a moment. Bloomberg Television will be returning to its regular program Bloomberg GO.