James Bullard, president of the St. Louis Federal Reserve, has a message that should be a wakeup call for all the yield-hunting investors who have been parking their money in risky instruments like junk bonds and exotic lite covenant bonds.
“The U.S. economy is approaching normal conditions in terms of the main macroeconomic goals assigned to the Federal Reserve,” Bullard said on Thursday in an address to the Greater Owensboro Chamber of Commerce. “However, the policy stance of the FOMC has not begun to normalize yet. … If macroeconomic conditions continue to improve at the current pace, the normalization process may need to begin sooner rather than later.”
His analysis may force many to wonder if it is possible that a hike in the target federal funds rate may come rather sooner than the mid-2015 timeline advanced by the central bank. Bullard is part of a growing chorus among central bankers who have started talking about the need for an early increase in the key policy rate now that the economy is growing faster than earlier anticipated.
Bullard spoke about a risky mismatch that has surfaced between where the Fed stands with respect to its macroeconomic goals and its monetary policy stance. This mismatch, according to Bullard, may become problematic at a later point if monetary policy is not normalized at the right time.
To measure how close the economy is to the goals set by the Federal Open Market Committee, Bullard used a function that depends on the distance of inflation from the FOMC’s long-run target and on the distance of the unemployment rate from its long-run average. The target rate for inflation was set at 2 percent, the same as the Fed’s inflation target. The long-run average rate of unemployment was set at 5.35 percent, the midpoint of the central tendency of the FOMC’s Summary of Economic Projections released in June.