The U.S. recession is fading but the economy will not recover in a meaningful way before the end of this year and deflation remains a risk in this climate, a top Federal Reserve official said on Thursday.
Dallas Federal Reserve Bank President Richard Fisher also said that official foreign holdings of U.S. government bonds had grown and appetite to hold the country's assets remained intact, despite expected record U.S. government deficits.
There continues to be strong demand for longer duration Treasuries, Fisher told the Washington Association of Money Managers in a speech. A steep sell-off in the U.S. government bond market on Wednesday was blamed in some quarters by a decline in foreign demand for U.S. assets.
Fisher also said he had not detected any evidence that the Chinese wanted to significantly alter their U.S. Treasury holdings during a recent trip he had made to Beijing.
They have no desire to inflict harm on the financial markets of the United States because they would inflict harm on themselves, he said.
The Fed has promised to buy $300 billion of longer-dated U.S. Treasuries and $1.45 trillion of agency mortgage debt and discussed increasing this program at its last policy meeting on April 28-29.
Fisher declined to say if he favored ramping up the purchases. The gap between 2- and 10-year government bond yields widened to a record 2.75 percent on Wednesday and some economists said this yield curve steepening might dampen the economic recovery and trigger more Fed asset buying.
But Fisher said it was not clear if the curve steepened on worries over upcoming Treasury supply to finance record U.S. fiscal deficits, or because of a brighter economic outlook.
I think it is probably a little bit of both, discounting the supply of new debt, but I detect...there is a pick up in confidence about the future, Fisher told reporters after the speech. The distinction matters.
Economists say the Fed is much more likely to ramp up the asset purchasing program if it thought the yield curve had steepened due to an increase in the risk premium being charged by investors to buy U.S. assets, because this would make credit more expensive for businesses and households.
But if the yield curve steepened because investors thought the economic recovery was on track, and the Fed would at some point begin to raise its benchmark overnight funds rate from current levels of almost zero, this would be a healthy development that would not warrant more Fed asset buying.
Fisher, who is not a voting member of the Fed's policy-setting committee this year, said that inflation would stay meek amid a tepid economic recovery.
However, he also emphasized that the Fed was well aware its aggressive expansion of the central bank's balance sheet through the purchase of assets like Treasuries and mortgage backed securities had long-term inflation implications, and it was focused on getting its exit strategy right.
Nobody I know on the (Fed's policy) committee wants to maintain our current posture for any longer and to any greater degree than is minimally necessary to restore the efficacy of the credit markets and buttress economic recovery without inflationary consequences, he said in the speech.
Indeed, as I speak, we are studying ways to unwind our balance sheet in a timely way, Fisher added.
This did not sound like an immediate concern for Fisher, who said he expected the economy to find its footing, but thought it would not post a vigorous rebound, or even a more modest 'U' shaped recovery.
I would be delighted, but surprised, if meaningful sustained growth gets under way before the end of the year, Fisher said.
Fisher also acknowledged criticism that some of the Fed's robust actions to shelter the U.S. economy had veered onto turf that could be called fiscal policy. This has raised questions of Fed independence, as well as whether U.S. lawmakers might want more say in the running of the central bank.
There have been suggestions that Congress should be involved in the selection of Federal Reserve Bank presidents, Fisher said, referring to himself and the 11 other heads of the dozen regional Federal Reserve banks.
The U.S. president appoints the seven members of the Fed's Board of Governors in Washington, subject to the approval of the Senate, but the 12 regional Fed chiefs are selected by their local business communities, and approved by the Board.
I trust that Congress will resist this initiative and not upset the careful federation that has for so long balanced the interests of Main Street with those of Washington, just as we at the Federal Reserve must resist the urgings of some to accommodate the short-term financing needs of the Treasury, he said.
(Reporting by Alister Bull; Editing by Diane Craft)