Fed officials back cautious policy approach in light of economic uncertainty

By Michael S. Derby

(Reuters) -New York Federal Reserve President John Williams said on Friday the U.S. central bank's monetary policy is in the right place given the myriad uncertainties facing the economy, noting that there's no urgency to make any changes to interest rates.

"Modestly restrictive" monetary policy "is entirely appropriate given the solid labor market and inflation still running somewhat above our 2% goal," Williams said in a speech in the Bahamas.  

In comments to reporters after his formal remarks, Williams said the Fed eventually will need to cut rates back to a level deemed neutral in regard to its impact on the economy. But in the meantime, "the downside risk to economic growth and the upside risk to inflation (are) both very high," in a climate where broader government policies are shifting rapidly and unpredictably, he said.

With monetary policy "in a good place" to deal with what lies ahead, Williams said "let's collect more data" and "we're not in a hurry" to make any changes in the setting of monetary policy. 

Chicago Fed President Austan Goolsbee echoed Williams' monetary policy caution, telling CNBC on Friday that uncertainty argued for the Fed standing aside until more clarity emerged. Goolsbee said the economy was strong and that he's waiting to see how President Donald Trump's tariffs, which many economists expect to worsen a challenging inflation situation, play out.

UNCERTAIN OUTLOOK

Williams and Goolsbee weighed in two days after Fed policymakers left the central bank's benchmark interest rate in the 4.25%-4.50% range and signaled they still expect to lower it at some point later this year. 

At the same time, Fed officials acknowledged considerable uncertainty about the outlook amid the Trump administration's dramatic and often chaotic policy changes, which they expect to help drive up inflation pressures, at least in the short term.

In his speech, Williams said that the economy started 2025 on a good footing, adding that while the cooling of inflation has been a bumpy process, the job market is in better balance and is not itself a driver of price pressures. 

Looking ahead, Williams said he sees growth slowing in part because of lower immigration rates. But he added, "it's hard to know with any precision how the economy will evolve."

"There are many scenarios that could play out, depending on fiscal and trade policies and geopolitical and other developments," Williams said, adding that "it is hard currently to assign probabilities to these scenarios."

Williams also told reporters that "the downside risk to economic growth and the upside risk to inflation (are) both very high" and added that, while the Fed knows more about what sort of import tariffs Trump is pursuing, details are still emerging and the impact is unclear.  

The New York Fed chief also addressed recent data that has tended to point to a notable rise in the expected path of inflation over the near-term, which has added to other data indicating a souring in the public mood as the Trump administration aggressively downsizes the federal government and cuts spending.

"There are no signs of inflation expectations becoming unmoored relative to the pre-pandemic period," Williams said, adding that "households expect an inflation shock will gradually decay over the ensuing years."

BALANCE SHEET

Williams also weighed in on the Fed's announcement at this week's policy meeting that it would slow the pace of its balance sheet drawdown to negligible levels as it navigates government financing volatility and some emerging signs of tightness in money markets. He said "this week's decision to slow it further is a natural next step" in an effort that's shaved just over $2 trillion off Fed holdings.

Fed Governor Christopher Waller was the only voting member of the central bank's policy-setting committee to oppose the deceleration in the pace of what is called quantitative tightening. Starting in April, the Fed will reduce the monthly cap on the runoff of Treasuries from its balance sheet to $5 billion, from $25 billion. The monthly cap on the runoff for mortgage-backed securities remains at $35 billion.

In a statement on Friday, Waller explained that there's still plenty of liquidity in the financial system, which gives the Fed the space to continue retiring bonds with little risk it will go too far and destabilize markets. 

In stating his preference for the pace of the runoff to have been left unchanged, Waller noted that the Fed has a range of tools that could be used to deal with any undesirable fluctuations in liquidity. He also said he'd like the central bank to create a plan to deal with the use of those facilities. 

Ahead of this week's policy meeting, Cleveland Fed President Beth Hammack said in an interview with Reuters that she also wanted a steady drawdown of the balance sheet, which currently stands at about $6.81 trillion. She said the central bank's tools could address any market hiccups.

(Reporting by Michael S. Derby, Howard Schneider and Ann Saphir; Editing by Paul Simao)