Why Kansas City Fed’s George favors a faster and higher rate rise

Market Realist

Overview: Will the Fed's doves and hawks find common ground? (Part 6 of 11)

(Continued from Part 5)

Esther George

Esther George has been the head of the Federal Reserve Bank of Kansas City since October, 2011. The Kansas City Fed oversees the Tenth Federal Reserve District which consists of Colorado, Kansas, Nebraska, Oklahoma, Wyoming, northern New Mexico, and Western Missouri.

Ms. George has been a vocal opponent to the Fed’s monthly asset purchase program, voting against purchases at every Federal Open Market Committee (or FOMC) meeting held in 2013, when she was part of the Fed’s policy making body. She was “concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations” and partly because “of the complications these actions have for normalizing monetary policy.” As head of the Kansas City Fed, she will be a voting member on the FOMC in 2015.

On the path and lift-off of the Fed funds rate

In a speech at the Hoover Institution in California on May 29, Esther George indicated that she would like to see a higher rates environment “in response to improving economic conditions” as soon as the Fed’s taper of monthly asset purchases ends. She felt market participants were taking on higher-risk activities in search of higher yields. Also, she believed that the low rates environment has adversely affected the margins of banking firms.

While Esther George is in favor of a gradual lift-off in the base rate, she would prefer the increase to come “somewhat sooner and at a faster pace.” She believes that “keeping rates very low into late 2016 will continue to incentivize financial markets and investors to reach for yield in an economy operating at full capacity, posing risks to achieving sustainable growth over the longer run,” she said, speaking in Breckenridge, Colorado on June 3.

For more on Esther George’s speech in Colorado, please read the Market Realist series, Kansas City Fed President—economic and monetary policy outlook.

Investor impact

Banking firms include financial institutions like Bank of America and Wells Fargo. Both firms are part of the S&P 500 Index (SPY). Exchange-traded funds (or ETFs) like the SPDR Financial Select Sector ETF (XLF), the SPDR S&P Bank ETF (KBE), and the Vanguard Financials ETF (VFH) also have investments in both Bank of America and Wells Fargo. A rate increase that is faster and higher than markets expect, would benefit the net interest margins at these firms, provided they can charge borrowers higher rates of interest than the rate paid by them on their liabilities.

However, bond markets (BND) would be adversely affected because bond prices and yields move in opposite directions.

 

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