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Slow Fed Balance Sheet Unwind May Be Destabilizing Markets, Fed's George Says

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03/09/2018 | 02:37am CEST

By Michael S. Derby

Federal Reserve Bank of Kansas City President Esther George warned Thursday the languid pace of the central bank's balance sheet shrinkage effort may be causing negative effects on financial markets, in remarks that again called for continued rate increases.

"Asset prices may have become distorted relative to the economic fundamentals" due to the now completed central bank bond buying effort that took place during and after the financial crisis, Ms. George said in the text of a speech to be presented in Lincoln, Neb.

Although the Fed has started allowing its roughly $4.5 trillion portfolio to shrink, it may not be doing it fast enough, Ms. George said.

"The very slow pace of our balance sheet normalization may still be contributing to a buildup of various financial imbalances," the official said. "While until recently, financial markets remained remarkably stable, it is not uncommon to see volatility rise when asset prices become inflated and investors struggle to find a new equilibrium."

Ms. George isn't currently a voting member of the interest-rate setting Federal Open Market Committee. She has consistently argued in favor of rate rises for some time and has worried very easy Fed policy is running the risk of creating unwanted inflation and unstable financial markets.

Ms. George's inflation warnings haven't come to pass, but markets have been volatile of late as good economic news has driven many in markets to expect a more aggressive course of rate rises from the Fed this year. Markets have also been unsettled by a Trump administration trade agenda that most economists think is wrong headed and having potential to start an international trade war.

In her speech, Ms. George again made the case for rate rises. The central bank is broadly expected to boost its overnight target rate range at its meeting later this month.

"To sustain the expansion without pushing the economy beyond its capacity limits and creating inflationary pressures, it will be important for the Federal Reserve to continue its gradual normalization of interest rates," Ms. George said. "Given the current momentum in the economy, the FOMC will need to carefully calibrate its policy to lean against a potential buildup of inflationary pressure or financial market imbalances."

Ms. George was upbeat on the economy, and said that price pressures should converge on the Fed's 2% inflation target this year. She said recently passed tax cuts and stimulative government spending should be a modest boost for the economy.

"The good news is that the U.S. economy is currently growing at a moderate pace, with full employment and price stability," Ms. George said. She added, "risks to the outlook appear to be predominantly to the upside."

Write to Michael S. Derby at michael.derby@wsj.com

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