‘Maybe monetary policy isn’t all that tight,’ Bill Dudley says

A former top policymaker for the Federal Reserve has raised new concerns for investors to consider, starting with the possibility that interest rates are still not high enough to restrict U.S. economic growth.

Borrowing costs have been between 5% and 5.25% — the highest levels in more than two decades — since last July. Nonetheless, data continues to show the economy is running hot, whether it’s measured by the labor market, gross domestic product, or inflation.

One possible explanation may be that the neutral, inflation-adjusted level of interest rates — which neither stimulates nor restricts growth — is above the Federal Reserve’s estimate of 0.5%, according to Bill Dudley, who served as the president of the New York Fed from 2009-2018. In an opinion column written for Bloomberg News, he wrote that the current level of the fed funds rate is possibly less restrictive than thought. It’s a view shared earlier this month by at least one current regional Fed official, Neel Kashkari of the Minneapolis Fed.

“Maybe monetary policy isn’t all that tight,” Dudley wrote on Monday. “Large and chronic fiscal deficits, together with public subsidies for green investment, have pushed up the neutral interest rate. If so, the Fed should hold rates higher for longer.”

Dudley doesn’t rule out the possibility that the economy could still slow by enough to “tilt the balance to rate cuts.” He implies that the full force of the Fed’s cycle of rate hikes may need more time to make its way through the economy, or that the U.S. may be getting a “transitory boost” from the strong labor market and the easing of supply-chain woes.

Investors returned from the three-day U.S. Presidents Day holiday in a mostly risk-off mood on Tuesday. All three major stock indexes
DJIA

SPX

COMP
were lower in New York morning trading, led by a 1.3% drop in the Nasdaq Composite, ahead of this week’s marquee event: Nvidia Corp.’s
NVDA,
-5.44%
earnings report on Wednesday. Meanwhile, Treasury yields were mostly lower, with traders focused on the health of China’s economy.

Meanwhile, gold futures
GC00,
+0.78%
were up 0.8% at $2,040 an ounce as investors flocked to the safety of the precious metal.