Few more meetings before need to change forward guidance To find out where the silent majority at the Federal Reserve stands on an issue, it is a good idea to see what Dennis Lockhart, the president of the Atlanta Fed. Lockhart describes himself as a “pragmatic moderate” at the central bank, looking to balance the views of the inflation-fearing hawks and the growth-promoting doves. With the central bank inching closer to the first rate hike since 2006, Lockhart sat down to give his views on the economy, the balance sheet and bubbles. Some highlights: Lockhart thinks it is too early to know if the economy is on track after a horrible first quarter and he is open to asset sales to shrink the central bank’s $4.4 trillion balance sheet. MarketWatch: As a moderate on the Fed, you must be under a lot of pressure these days? Getting pulled in all directions? Lockhart: To the extent that someone who is not defined as either a hawk or a dove, or an extreme dove, is part of a debate with points of view that range from—“We should go to lift off early because there is relatively little effective slack” to those who say “we should go longer because there is considerable slack,”—if you think of that as being pulled in one way or the other I suppose it is just that I am part of that flow of debate. MarketWatch: Are you more dovish than Yellen? Lockhart: I think I align pretty well with Janet. What I have been saying here in interviews is that I am still looking to mid-2015 (for the first rate hike). Using a simplistic categorization that my staff came up with, I am more of a U-6er than a U-3er… MarketWatch: That means…U-3 is the nonfarm unemployment rate? Lockhart: U-3 is the conventional unemployment rate, and I am more in the camp that says I don’t think it does not tell the whole story and therefore you have to take in consideration a lot of other indicators. Maybe not 19 indicators but a lot of other indicators and U-6 is a way of capturing that idea. But I have been taking the position that if the data come in above expectations in coming months I am certainly not ruling out something earlier than mid-2015. MarketWatch: What would you want to see? What would victory look like to you? Lockhart: Well, if you are a U-6er and you are looking for progress in areas like part-time-for-economic-reasons or marginal attachment, which would suggest people returning to the workforce who were not in the unemployment calculation, or increased hours that would absorb the part-time into full-time work, you are looking at those kinds of indicators to try to synthesize a sense of the health of the labor market and so it is not highly mechanical, because you can put different weights on different things but clearly we would like to see broader progress with broader measurement than simply the unemployment rate. MarketWatch: In an early interview, you described the economy’s rebound after the first quarter as “tentative.” You are not convinced the second half will be solid? Lockhart: I am trying to make the point that it is early to draw conclusive notions of what is really going on. The first quarter was horrible. Second-quarter GDP growth was quite strong, but final sales was 2.3 [percentage points] of the 4%. So there was a big inventory component there. The third-quarter tracking estimates are around 3% which is what I am expecting as a run-rate growth rate, but they are tracking estimates. In the first quarter, we were looking at tracking estimates that turned out to be tremendously off what the ultimate measured results were. So I just think you have to be a bit tentative, at this particular point in time, in concluding that we’re on the track that we need to be on to get to lift off at mid-2015 or earlier. So I just want to let more time pass, more data come in, more accumulation of evidence that the track we think we are on, we are in fact on. MarketWatch: There is going to be pressure from some on the committee to rewrite the Fed’s forward guidance that rates will stay close to zero for a “considerable time” after bond-buying ends. Where do you stand? Lockhart: I think we are entering a period in which some tweaking of communications around those two words is appropriate to debate. My own position is that we can wait some meetings before making an adjustment, at least to “considerable period,” but, yes, we are entering a period in which it is a legitimate debate. MarketWatch: Your forecast on the first rate hike in mid-2015 is not based on the calendar? It is more about the economic conditions? Lockhart: Virtually every participant in the committee really adheres to this data-dependency point. And we have to keep reinforcing that and reinforcing that and reinforcing that. And that is, that the data, and to some degree, perhaps, some inputs that we get from the districts, through informal sources, are going to tell us what is really happening in the economy and lift off should be a function of that. MarketWatch: In other words, you would want the data to lead. If the economy turns up…and we have three strong job reports and the market starts to move… Lockhart: And measured progress against our objectives. The goal line for at least full employment is a debatable matter. The goal line for 2% inflation over the longer-term is not an easily debatable matter, but it is, by nature, hard to cut through the month-to-month and quarter-to-quarter transitory movements in the numbers to really distill the picture, and as the objective states it is over the longer run. So both of them are a little bit elusive. But every participant has some pretty distinct sense of what we’re trying to achieve and can measure progress toward that. MarketWatch: Do you want to see how the economy does after QE ends in October? Is that a factor for you? Lockhart: It is not a big factor in my mind. I doubt that there is much dependency on the remaining stub of QE in terms of how the economy is performing. We tapered in a very orderly, predictable way. In my mind, there would not have been a big difference between cutting it off in September or even July and just dealing with it at that time versus October. So I don’t think it is going to be a major factor at all. MarketWatch: Some Wall Street economists think the Fed’s balance sheet is going to stay as high as $4.5 trillion as far as the eye can see and that officials are kidding themselves that it is going to come down as soon as we can. Lockhart: I think it is going to be a very gradual reduction in the balance sheet assuming a kind of moderate pace of growth and assuming no reversal in the economic performance. I think the game plan is and should be a gradual reduction in the balance sheet that will start with ending reinvestment (of proceeds of maturing securities.) I am not one who wants to rule out asset sales but I think we’ve communicated that in all likelihood we are just going to let the balance sheet run off through maturities and that is going to take a while. MarketWatch: Do you think the committee would come around to support asset sales? Lockhart: I think under certain circumstances there could be a majority of the committee that says “yes, let’s have some asset sales.” I am one who has been arguing, “don’t rule out anything,” but you still have to give the markets and the public a sense of how this is going to play out, so you need a sort of base-case. The base-case in my mind is gradual and through natural processes of shrinking. MarketWatch: Former St. Louis Fed President William Poole thinks Congress will react negatively to the sizable payments the Fed will make to banks when it hikes the interest paid on excess reserves. Do you think the Fed can weather that storm? Lockhart: I think you are asking me to be a political analyst which is a little bit beyond my skill-set quite frankly. I would simply point out…that, if we are paying interest to reserves at a high level, it means the economy is performing at a high level and that welfare out there has been improved. And for that matter, I think politicians will be under less pressure from their constituents about the state of the economy and therefore if you look at that as a sort of necessary ingredient of a good picture, I don’t know why you would overreact to that. And we are not going to be paying really elevated interest on excess reserves in the context of a weak economy. MarketWatch: I would be remiss not to ask you about the state of financial markets as you hold a conference of the topic annually. Are there bubbles forming, frothiness to be concerned about? Lockhart: I think it is hard to deny that there are certain markets that are highly valued. I think the real question is, is that so widespread—underpinned by excessive leverage—that we are flirting with another systemic event. And I am not there. But I would not deny that we have some highly valued markets. MarketWatch: You are not worried about with rates so low, there is a misallocation of credit? Lockhart: I try to frame this as whether there is something that monetary policy should address, in which monetary policy is the right tool to address it, because we are taking really severe systemic-scale risks. I am not in that arena in my thinking at this stage. MarketWatch