Fed’s Lockhart ‘comfortable’ with cautious bond taper in September

The US Federal Reserve could announce a cautious first step in tapering bond purchases at its meeting next month, provided there were no “really worrisome” signs the economy was faltering, a top US central banker said on Saturday.

Atlanta Federal Reserve Bank President Dennis Lockhart said that recent evidence from the US economy had been mixed, and growth forecasts might need to be revised lower, but the underlying recovery remained intact.

“I can get comfortable with September, providing we don’t get any really worrisome signals out of the economy between now and Sept 18,” said Lockhart, referring to the Fed’s next meeting, which is on Sept 17-18.

Lockhart — viewed as a centrist, and therefore a good guide to which way the central bank is leaning — is not a voting member of the Fed’s policy-setting committee this year.

Speaking on the sidelines of the Fed’s annual monetary policy symposium in Jackson Hole, Wyoming, he said the main thing was that no new evidence emerged that undermined his assumptions for a gradual US recovery.

“The data are essentially a way of testing a basic set of assumptions. And I can get comfortable with an initial step in terms of tapering, as long as I am comfortable that we are on that basic flight path for the economy,” he said.

The Fed has said it expects to begin scaling back bond purchases later this year from a monthly $85 billion pace.

Setting a high bar

Markets think this will start at the next meeting, and Lockhart’s comments indicate a fairly high bar, in his mind at least, to delaying a move to later in the year. That said, he explained that nothing was set in stone.

“I don’t think it is a foregone conclusion that it is September. It could be October, or December. That is going to be a committee judgment,” he said, referring to the two other remaining scheduled Fed meetings in 2013.

The strength of the August payroll report, due Sept 6, is viewed by economists as vital to the decision, after recent data that has signaled softness in the US housing market.

Lockhart agreed that the August jobs report was the most important piece of information available to policymakers between now and the meeting next month.

A disappointingly tepid 162,000 jobs were created by the US economy in July. He said that the August numbers could confirm if that was a passing dip, or the start of a more lasting period of labor market weakness.

He declined to specify what size of tapering he favored, saying it could be modest in scale, although there might be technical reasons why making a larger reduction made sense.

“I am comfortable with a token to begin, to basically break the ice. I am comfortable with that. But it may be more practical to do more than a token.”

The US central bank has held interest rates near zero since late 2008. It has also tripled the size of its balance sheet to over $3.6 trillion through three rounds of massive bond buying, also called quantitative easing, to press down longer-term borrowing costs in a bid to spur investment and hiring.

Notwithstanding those efforts, it unleashed violent global financial market volatility when it announced in June that it expected to scale back bond buying later this year.

The subsequent bond market sell-off drove up US government bond yields and mortgage rates by over 100 basis points, tightening financial conditions in the US.

However, Lockhart was not so sure that the news of tapering would cause a similar adverse reaction.

“I am prepared to believe it is substantially priced into bond prices,” he said. “So I would not make a prediction with a lot of confidence as to whether, when and if the policy is executed ... whether that would create more tightening.”