STONE MOUNTAIN, Ga. - Atlanta Federal Reserve Bank President Dennis Lockhart said Wednesday he remains "comfortable" with the Federal Open Market Committee's expectation that the federal funds rate will need to stay near zero "at least through late 2014," but said he is "reticent" about a third round of large-scale asset purchases until such time as the economy weakens.
Lockhart, a voting member of the policymaking FOMC, didn't rule out the use of "sterilized quantitative easing" after the conclusion of the "maturity extension program" or "Operation Twist" at the end of June. But he poured cold water on the idea, indicating that there had been no serious discussion of it by the FOMC.
The idea of financing purchases of long-term securities through reverse repurchase agreements "came from outside, not inside" the Fed, he told reporters on the sidelines of an Atlanta Fed annual financial markets conference.
Lockhart indicated he would expect the Fed's policy of reinvesting principal received from its holdings of agency debt and agency mortgage-backed securities in MBS will continue after June 30 because to cease reinvestment would amount to a tightening of monetary policy.
He expressed disappointment in last Friday's March employment report but said he is not prepared to conclude, on the basis of one's month's data, that the uptrend in employment and downtrend in unemployment has run out of momentum.
Some Fed officials have said the FOMC may have to raise the funds rate before late 2014, but Lockhart made clear he is not in that camp.
"I certainly wouldn't call (the late 2014 "forward guidance") a mistake," he said. "We communicated a conditional statement ... . I think that helped many decision makers in the economy to build their own assumption about the rate environment ... . I think that in that sense it was positive."
"The 'through late 2014' language is still broadly aligned with our analysis of the economy and forecast," Lockhart said. "I'm comfortable with it."
MNI asked Lockhart whether he is concerned about the market reaction or the behavior of bond yields when Operation Twist -- the sale of short-term securities in the Fed's portfolio and purchase of long-term b bonds to lower long-term interest rates.
"You always have to be concerned about how the market reacts or how the market behaves when an explicit policy of the Fed ceases or comes to an end," he replied.
"My ability to predict that is very limited ... and I don't see that anticipating a new policy like Operation Twist or sterilized Q.E. or whatever you want to call it is a question of the ending of previous maturity extension program," he continued. "The real question is what are conditions overall, how supportive (are they) of the recovery and does it make sense to do more to try to support recovery."
Some weeks ago, there was a report that the Fed was considering "sterilized quantitative easing" after Operation Twist concludes. The notion was that the Fed would finance long-term bond purchases through reverse repurchase agreements. There was concern among Fed watchers that the program might backfire by pushing up short-term rates in an effort to hold down long-term rates, and MNI was reliably informed that there was no serious Fed proposal to do that.
Asked about it, Lockhart grinned and said, "My perspective on this is that this came from outside, not inside."
Asked further whether it's something the FOMC might consider, he said, "I think it's one of our options." But he said "I really haven't been presented with any detailed analysis" of sterilized Q.E. He called it "a notional idea."
As for a straight, unsterilized, third round of quantitative easing, Lockhart indicated he still thinks there is a high bar to launching a "QE3."
"My view really hasn't changed," he said, adding that he and his fellow policymakers would have to "do a cost-benefit analysis of the idea " to determine "what would be achieved by another round versus the costs that have to be estimated because of the future costs that involve risks related to unwinding a large balance sheet."
"At the moment I am still not convinced that the another round, at least in this time frame, would achieve a great deal," Lockhart continued. "For that reason I'm somewhat reticent to consider Q.E. at this time."
QE3 would be "a policy that would respond more to a very dramatic negative change of direction of the economy," marked by "rising unemployment or plummeting growth," he went on. QE3 is "something to hold in reserve for such a development."
Before last Friday's employment report, speculation about QE3 had diminished, but such talk has increased again since the Labor Department reported a much less than expected 120,000 rise in non-farm payrolls.
Lockhart said he "would have preferred to see double" and called the meager job gain "disappointing." But he stressed "it's one month's number" that "could very well have been affected by weather with a pull-forward into February" and that could be revised upward.
"It's way too early to conclude that the economy is sputtering and that the employment progress we made is stalling out," he added.
In the weeks leading up to the March employment report, Fed Chairman Ben Bernanke had suggested that monthly job gains of nearly 250,000 might not be sustainable because they were "inconsistent" with the pace of GDP growth. He referred to the "Okun's Law" theory that the economy has to grow by at least 2% to absorb new entrants to the labor force before unemployment can fall.
Bernanke warned that bigger job gains from December through February might just be a "catch-up" to the heavy lay-offs of 2008.
Asked by MNI whether he shares those sentiments, Lockhart said, "My posture on that correlation before last week's employment info was somewhat more skeptical than others." And he said he is still "more inclined to view the economy as continuing to gain traction."
"I would have expected a continuation of employment gains at the levels we'd been seeing," he said. The March report "gives slight pause to those who are skeptical" of the Okun's Law thesis, but "I don't think it's decisive or conclusive that the Okun's Law thesis is correct ... . We need to see more data."
He said he still expects real GDP growth between 2.5% and 3% this year.
"I'm not ready to revise that down," he said. "We still see signs of adequate strength to achieve that growth ... . Manufacturing is continuing to expand; consumption has not fallen off the table; it's growing very slightly ... . The economy's health has not been reversed dramatically just because of one indication of the labor market last week."
Lockhart said he wouldn't want to speculate how many of his fellow policymakers are comfortable with the economy's performance. "Everyone on the Committee ... every member, every participant is sizing up the evolution of the economy" and "weighing whether to do more."
"There are a number of options" if there is "a need to do more," he said, adding that those options "include further communications initiatives or enhancements."
"The economy still has some question marks," he said, so "it's hard for me to take any option off the table."
Lockhart said the run-up in gasoline prices is "something to watch" but said "I doubt at this level they'll derail the economy."
As for inflation, he said "I'm satisfied that inflation is broadly consistent with our now formal target of 2%."
Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.
