Fed's Waller calls Q3 US GDP growth a 'blowout,' but newer data suggest slowdown

By Howard Schneider and Lindsay Dunsmuir

WASHINGTON (Reuters) - Federal Reserve policymakers fresh from last week's decision to hold the policy rate steady are weighing strong economic data, some signs of a slowdown, and the impact of higher long-term bond yields as they consider if they will need to hike rates further to bring down inflation.

Third-quarter U.S. economic growth, at an annualized 4.9% rate, was a "blowout" performance that warrants "a very close eye when we think about policy going forward, Fed Governor Christopher Waller said on Tuesday.

An ardent advocate of aggressive Fed rate hikes to battle high inflation, Waller did not include a policy recommendation in his remarks to an economic data seminar at the St. Louis Fed. His presentation also noted signs that job growth was slowing, and what he called the "earthquake" wrought by higher and potentially growth-dimming long-term bond yields.

But in comments to the Ohio Bankers League, Fed Governor Michelle Bowman said she took the recent GDP number as evidence the economy not only "remained strong," but may have gained speed and require a higher Fed policy rate.

"I continue to expect that we will need to increase the federal funds rate further," Bowman said.

At yet another event, Dallas Fed President Lorie Logan noted that "all of us" have been surprised at how strong the economy has been, and that despite some progress inflation is trending toward 3% rather than the Fed's goal of 2%. The labor market despite cooling remains "very tight," she said, and longer-term bond yields, whose rise helped convince she and others to leave rates on hold last week, have fallen.

"We're going to continue to need to see tight financial conditions in order to bring inflation to 2% in a timely and sustainable way," Logan said, adding that she'll watch both economic and financial conditions as the Fed's next meeting, in December, approaches.

Explicit endorsements for higher rates have become rarer among Fed officials since July, when the Fed raised the benchmark rate by a quarter point, to the current 5.25% to 5.5% range, in what many analysts expect will prove the last move in a monetary tightening cycle that began in March of 2022.

Indeed more recent data suggest the outsized pace of growth in the July-September period may prove an outlier for the year, with manufacturing and job growth both cooling in October, a bank loan officers survey showing continued credit tightening and a drop in loan demand in recent months, and a New York Fed report on Tuesday noting a rise in consumer loan delinquencies.

That combination of data potentially shows the sort of economic slowing that Fed officials have expected as the sometimes slow-moving impact of central bank interest rate hikes is felt more broadly.

Based on incoming economic data, the Atlanta Fed's GDPNow model suggests fourth-quarter gross domestic product will grow at an annualized rate of just 2.1%, edging towards a pace Fed officials might view as allowing inflation to continue slowing to their 2% target.

By the Fed's preferred personal consumption expenditures price index inflation was 3.4% as of September.

'CLEARLY CALMING DOWN'

Many economists expect the Fed to hold interest rates steady at the upcoming Dec. 12-13 policy meeting, in part due to that anticipated slowdown and the ongoing tightening of borrowing and credit conditions.

In comments on Monday, Fed Governor Lisa Cook took particular note of rising debt stress. While it was not broadly apparent among "resilient" U.S. households, she said, "we are seeing emerging signs of stress for households with lower credit scores, and individual borrowers may struggle with debt burdens in the face of economic hardships," a dynamic that at the margin will begin to trim consumer spending and, in the extreme, could make banks even more reluctant to lend.

In comments to CNBC on Tuesday, Chicago Fed President Austan Goolsbee noted that inflation has been slowing, and that the rise in market-based interest rates, "if ... sustained at high levels" most likely represents a tightening of credit for families and businesses.

The yield on the 10-year Treasury note, which had risen about a full percentage point since July, was still up about 75 basis points from then despite a drop since last week.

"We have got to take that into account ... We should expect to see that, with a lag, working its way through the economy. So we're all paying attention and trying to figure out what the driver is," Goolsbee said.

However neither Goolsbee nor Minneapolis Fed President Neel Kashkari, who spoke to Bloomberg Television on Tuesday, ruled out further Fed rate increases.

Noting, as Waller did, the recent "hot" readings on economic activity, Kashkari said "that makes me question if policy is as tight as we assume it currently is."

"If you saw inflation tick back up and you saw continued very strong economic activity in the real side of the economy, that would tell me we might need to do more," Kashkari added.

(Reporting by Howard Schneider and Lindsay Dunsmuir; Additional reporting by Michael Derby and Ann Saphir; Editing by Paul Simao and Andrea Ricci)