Duke: Recovery, not Fed moves, raising interest rates

By Reuters
Posted Jan. 7 at 1:20 p.m.

U.S. economic recovery may have started to gain traction and market expectations for stronger recovery have bid up interest rates, Federal Reserve Gov. Elizabeth Duke said Friday.

Duke, in prepared remarks to the Maryland Bankers Association, said she believes expectations will remain subdued despite signs economic recovery is gaining momentum.

“Overall, the recovery in economic activity to date has been uneven and has not been sufficient to reduce unemployment noticeably. But I am encouraged by signs that the recovery may have gained traction recently,” Duke said.

She said sustained gains in consumer spending and business investment along with an easing of credit conditions will reinforce each other, boosting confidence and reinforcing a recovery that will gradually reduce unemployment over time.

She defended the Fed’s move to boost purchases of long-term Treasury debt by $600 billion after U.S. politicians said it would stoke inflation and critics abroad saw it undercutting the dollar and leading to competitive currency devaluations.

Duke said there was “accumulating evidence these and other asset purchases were successful in exerting downward pressure on long-term interest rates.”

Duke acknowledged that rates have risen since the Fed announcement but said this was due to market expectations for a strengthening recovery and a ratcheting back of investors’ expectations for Fed purchases.

“I believe that the current rise in rates is due to exactly to this latter circumstance — a strengthening in market participants’ outlook for the economy and a corresponding decrease in the market’s expectation for future accommodation,” she said.

Duke said she was confident that the Fed can manage risk associated with withdrawal of monetary accommodation at the appropriate time, including the elevated reserves on the Fed’s balance sheet.

“My view is that the elevated reserve balances would be inflationary only if they prevented the FOMC from effectively removing monetary accommodation by raising interest rates when the time comes to remove such accommodation, and I am convinced that will not be the case,” she said.

The Fed can drain reserves by replacing them with repurchase agreements and term deposits and can sell assets to exert upward pressure on rates.

Duke said one caveat to her outlook is the still weak housing market, which will not improve until unemployment is lowered and the overhang of foreclosed homes reduced.

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