The Federal Reserve must be on the lookout for financial imbalances given the usual timing of fiscal policy stimulus, said Fed Governor Lael Brainard on Friday.
It was “unusual” to have sizable tax cuts and a boost in government spending at this point of the business cycle, Brainard said in an interview on CNBC.
“At a time when we are growing above trend and resource utilization is tightening, we want to make sure that we don’t see any imbalances developing,” she said.
Brainard said two possible areas of imbalances have caught her eye.
“One is that asset valuations are somewhat stretched,” including tight junk bond and leveraged loan spreads, she said.
And the second is growing leverage in the U.S. corporate sector, Brainard said.
Looking at consumers, borrowing remains quite moderate as households have only just completed deleveraging in the wake of the financial crisis, she said.
In a separate interview on CNBC, Minneapolis Fed President Neel Kashkari said he did not see “bright red flashing lights that a crisis is coming” from financial imbalances.
He said the Fed would not alter policy if stocks pull back.
“If markets correct, I don’t think that is going to be what drives our interest rate policy,” he said.
Brainard, who has been dovish since joining the central bank, said she supports the Fed’s target for gradual rate hikes this year.
Inflation is “just beginning to move” toward the Fed’s 2% target. This is “what one would expect” and is in-line with the Fed’s target of 2% inflation, she said.
On the other hand, Kashkari said he thought the Fed’s policy rate was close to neutral, suggesting he may not support additional rate hikes this year.
Kashkari said the Fed should be cautious because of the flattening of the yield curve. “It’s at least a yellow light flashing” that the premium between the 2-year Treasury note TMUBMUSD02Y, +1.06% and the 10-year note TMUBMUSD10Y, +1.50% is narrowing, he said. An inversion of the yield curve has been an accurate predictor of recessions. Other Fed officials, like Fed Governor Randal Quarles, have said they are not so worried about the flattening yield curve.
“Every time somebody says this time is different, it makes me nervous,” Kashkari said.
Brainard and Kashkari both agreed it was hard to guess how trade friction between the U.S. and China would develop. Retaliatory tariffs could dent global confidence and disrupt supply chains, they said.
The Dow Jones Industrial Average DJIA, -0.82% was down nearly 300 points late Friday as the 10-year Treasury note yield rose toward 3%.