July 17, 2014 / 8:26 PM / 5 years ago

UPDATE 1-Fed's Bullard backs repo rate, cites bond bubble worry

(Adds quotes from question and answer session, interview with reporters)

By Michael Flaherty

OWENSBORO, Ky., July 17 (Reuters) - St. Louis Federal Reserve President James Bullard threw his weight behind the reverse repo, calling it the Fed’s most important rate, and said he was worried about bond yields being “exceedingly low.”

Bullard also took a strong stance against views of Fed Chair Janet Yellen, saying that people should not expect an influx of workers to join the work force as the economy improves.

Bullard, speaking to business leaders at an event here on Thursday, said inflation is starting to pick up, after being surprising low for much of the year, but he stood by his forecast for a Fed rate hike late in the first quarter of 2015.

In response to a question on the Fed’s reverse repurchase program, Bullard stood strongly behind the tool, at a time when the Fed is debating its use, and the risks that it may bring.

Bullard said he supports having the federal funds rate trade between the reverse repo and the interest on excess reserves (IOER) rates, where the repo acts as a floor.

“I think a gap of 20 to 25 basis points would be reasonable between the IOER and the reverse repo rate,” Bullard said. “And then we can expect the federal funds rate to trade in between those two values.”

The New York branch of the central bank has been testing the reverse repo facility since September as a way to help control short-term interest rates, and has seen strong demand from money market funds and other bidders.

In reverse repos, the Fed temporarily drains cash from the financial system by borrowing funds overnight from banks, large money market mutual funds and others, and offering them Treasury securities as collateral.

Bullard was asked from an audience member Thursday if he worries about bond yields and whether a bond bubble is forming.

“Bond yields are extraordinarily low,” Bullard replied. “I have worried some about this issue. I think when the 10-year Treasury was at 160 basis points, that seemed especially low to me.” The benchmark 10-year note was yielding 2.46 percent on Thursday.

Bullard said in his prepared remarks that the labor participation rate is expected to fall and the government should not expect an influx of workers.

He cited an index of aggregate hours worked showing a full recovery to pre-recession levels as a sign that the unemployment rate will continue to drop.

Bullard’s views on the labor market’s recovery, and the lack of people ready to join the work force, runs counter to Yellen’s view that there is a lot of slack in the job market. Yellen believes there is an influx of workers ready to join when the economy recovers, a point backed by the White House’s Council of Economic Advisers on Thursday.

Bullard also said the macroeconomic goals of the Federal Open Market Committee are close to being met, and yet its policy settings remain far from normal.

“While this mismatch is not causing macroeconomic problems today ... the mismatch may cause problems in the years ahead as the economy continues to expand,” Bullard said.

Reporting by Michael Flaherty; Editing by Andrea Ricci

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