Mary Daly, president of the Federal Reserve Bank of San Francisco, spoke with Yahoo Finance to discuss the weaker-than-expected April 2021 jobs report and where Fed policy is headed next.

Below is a transcript of her appearance on May 10, 2021.

-

BRIAN CHEUNG: President Daly, I wanted to kick off this conversation with just that jobs report covering the month of April that everyone was watching. It feels like it really missed expectations across the board. From your perspective, what were your expectations for April and what do you think led to that surprise last Friday?

MARY DALY: So first, Brian, thanks for having me on. So, the jobs report was disappointing for those who expect to just be able to extrapolate the momentum that we've seen percolating up into what's going to happen in the future. But this kind of volatility is very normal in turning points. We've seen it in every other recession and expansion that I've been through. The difference now is that the size of the volatility of course is much larger, much bigger, because we went through such a massive shock with COVID. So for me, I wasn't as disappointed as many. What I see is — let's start with what we know. More than 8 million people who had jobs prior to the pandemic, don't have jobs today. So that's a deep hole we have to dig out of. And of course we're adding new graduates, right about now, to the labor market. So we also have to absorb those individuals, make sure they have opportunities.

I also see a labor market that has disproportionately affected women, among many others as they’re home schooling and trying to do caretaking and manage job opportunities. So we're in a transition state. I see some momentum building, I'm very encouraged. I remain bullish about the future, but we're not there yet. And we're going to have fits and starts and we have to stay steady in the boat.

BRIAN CHEUNG: So president Daly you mentioned you weren't as disappointed as maybe others were but can you explain maybe, what did you glean from that jobs report that tells us a little bit more about the unique dynamics of this labor shortage? There's been some rigorous debate about the impact of unemployment insurance, whether or not that's holding people back from wanting to rejoin the workforce. Do you think that's an element from what we saw on Friday?

MARY DALY: Well I think we shouldn't call it a shortage. We have more than 8 million people who remain on the sidelines, what we have is bottlenecks, just the normal disruptions. Remember we were completely out of the economy, and now we're re-entering. And we're seeing these kinds of difficulties, these bottlenecks everywhere. We're seeing them in — I was in a restaurant the other night, and they ran out of lettuce, I asked what happened? Why did you run out of lettuce? Lettuce is an important part of your, your production, and they said that they didn't know how many people were going to show up, and then the suppliers don't know how many people are going to show up, so it's just starting out.

That same logic can be applied to shipping, can be applied to lumber, and of course be applied to people. The labor market is in a state of flux and there are many constraints that are also there, including not only back to school, people aren’t fully vaccinated, there's still health risks, and most employers can't guarantee you work that won't be interrupted for any period of time because we're not through COVID. So this is just a transition point, I would hesitate to call things shortages, and instead think of them as bottlenecks.

BRIAN CHEUNG: So you mentioned a shortage on lettuce, I hadn’t heard that - I've heard about chicken wings and other issues, but I haven't heard about lettuce. I wanted to ask about how that impacts maybe the inflationary dynamics we heard about other supply chain issues at hand that might be incentivizing producers to raise their prices. So how do you figure out what's transitory as the Federal Reserve as described some pressures, there's some measuring differences for example as you measure year-over-year, but how do you parse out what's transitory from what might need more secular demand-pull types of inflation that could be more of a concern from the Fed’s perspective?

MARY DALY: Sure, absolutely. And that's a fantastic question. So, there is no special science to this but here's some starting points. The first thing you noted already as you take out the base effects, we had low prices at the depth of COVID. When prices return to normal levels we’re going to get a pickup in inflation. So that's going to contribute. But of course, we have these bottlenecks we just talked about. Bottlenecks cost spot prices to rise. So spot prices for shipping are a really good example. If you have a long term contract for shipping, you're great. If you have to pay the spot price for shipping, you're going to pay a little bit more. But those will relax as the supply constraints relax, and things get back into balance. So that will cause inflation to pop in the next several months, probably through the end of the year, even, achieving levels above 2%. But that's going to be transitory in our judgment — in my judgment. And it'll come back down to the underlying rate of inflation, which I think of is about 1.8 going forward. And we're going to continue to dig through the slack that we have — continue to get people back to work. And then, and only then, will we be able to achieve our 2%, on average, inflation target.

BRIAN CHEUNG: So all of those things together when does the Fed start to think about thinking about tapering its asset purchases right now it's paying about $120 billion a month in U.S. Treasuries and agency mortgage backed securities, when is the time from your perspective to start having those conversations? Is it now?

MARY DALY: Not yet. When you get a jobs report like you did and you see the volatility that we've had, you say, ‘OK we're on a good path, but we’re a long way from home.’ And when you're a long way from home, it's not yet time to start thinking about thinking about talking about relaxing the accommodations we've given. We need a bridge that gets us through the pandemic. We still have COVID with us, we're not done yet.

We have to get through the pandemic, and then be well positioned to grow the economy, bringing those 8 million plus workers back into the labor market. Back into their communities with productive jobs and mobility and delivering on the promise of the dual mandate: full employment and price stability.

BRIAN CHEUNG: Now, in the meantime there's been some concern from Fed critics about the impact of all this accommodation and whether or not things that we're seeing when those headlines about Dogecoin or Archegos are being fueled by easy money policy. So, from the Fed’s perspective, where are you seeing financial stability? There was a report that the Fed released last week saying that hedge funds could be a blind spot when it comes to leverage in the system, where do you think we are about a year into this aggressive monetary policy.?

MARY DALY: Let me tell you how I see it so I see it as we're always watching every aspect of financial system, after the financial crisis we study everything, quantitative and qualitatively on talking to contacts. And what I see is valuations in the stock market that are pretty high, hedge funds and prime money market funds that have embedded risks into them that we have to think about. But that's not just a reflection of policy, the policy is necessary to ensure that we get the economy back up to speed. But we do have to rethink what our financial system looks like going forward so that we can be resilient against shocks of all types, including — and also in a low interest rate environment, be resilient to needing to have interest rates low to bring millions of Americans back to work without concerning ourselves that this is causing financial instability.

So these are the problems ahead for multiple agencies, not just the Federal Reserve. And right now, our commitment — my commitment — is to ensuring that we get those individuals who lost their jobs, no fault of their own, back to work. We get inflation up to our 2% on average target, and we fulfill our responsibilities that Congress gave us.

BRIAN CHEUNG: Now with regards to the financial system, it seems like markets have been kind of confused about some of the wordings regarding maybe higher interest rates. And we did hear from Treasury Secretary Janet Yellen last week where she said I want to be careful about the wording here but you said, higher interest rates may have to rise somewhat to make sure that our economy doesn't overheat. What was your interpretation of those remarks?

MARY DALY: Well, I can't speak for the Treasury Secretary, so I will not. But here's what you know if you're trained as an economist: that as the economy builds up and we get to full employment and price stability, then we have to raise the interest rate at some point, normalize, so that we can get back to the steady state economy that’s in that place. My reading of what Treasury Secretary Yellen said was just that. And what that — but it doesn't give you a prescription for what to do now with policy. Right now we still have COVID, we haven't been fully vaccinated, we need to make sure that the momentum in the economy is continuing. The bridge that the fiscal agents put forth is there and I feel really reassured by that.

We will find out at some point when the economy is fully ready to go on, off of life support if you will, and on to fully on its own. But then that will be some time before it achieves full employment. So I think we're a long way from normalization, and I think of us all just knowing what the models look like eventually, we will normalize and that will be a good day.

BRIAN CHEUNG: Now I want to go back to the idea of maximum employment because regular people that were watching us may not have understood that last question, but they'll probably understand this question, which is: you've described the Federal Reserve's approach to maximum employment now as experienced experientially trying to find it. So that implies that it's more than just the headline unemployment rate. We know that the Federal Reserve is paying attention to inequality by race, by gender, by a number of other factors. So, what are you looking for in terms of this job markets recovery to make sure we are getting closer to the maximum employment?

MARY DALY: So when I look for is sort of a preponderance of evidence across the labor market. I have a labor market dashboard, if you will, and it grows in its complexity, every, every cycle because we have more information. We know more. But things that would be on that: the unemployment rate, the level of wage growth, the rate of hiring, the quit rate. Workers quit jobs when they feel secure they can find another one. So if the quit rate is low, you know that the labor market isn't quite as strong as you think.

I look at it by industry. Right now, if you looked at the tech sector, you'd think we were in a booming economy. But if you look at the hospitality sector, you know that that's not true. So you have to look at these sectoral decompositions. You can't be satisfied with any one number. What a broad based and inclusive goal means is that we're really here to achieve what we say, for every American. Everyone who wants a job can get one. We've created the conditions for that to happen. That's what the interest rate policy is about, all the while ensuring we have price stability. And so no one measure will do the trick. You need all of them and in the end, you know, we need to keep studying. We're a data dependent Fed. So being experientially waiting to find it doesn't mean we're waiting to find one number. It means we'll be very aware, as will all your listeners, when we get there. When we see that everyone we need has a job if they want one, and everybody has an opportunity in our economy, to participate.

BRIAN CHEUNG: And then I want to ask about climate change. The San Francisco Fed’s been doing a lot of research and hosted a conference. And we've heard from other parts of the Fed system as well that there's interest in maybe even incorporating some sort of paying mind to climate change in the regulatory framework. But there's been some criticism from Capitol Hill, the likes of Senator Pat Toomey who have criticized this as maybe mission creep on the part of the Fed, what do you have to say to those critics and why is the Fed kind of moving forward on a lot of this type of research?

MARY DALY: Let me start by saying that we welcome this kind of debate, I mean this is what really is part of a good system of our democracy: is that people raise their hand and say, ‘well I don't quite see that or I disagree with that.’ And then we come out to have discussions so I welcome the discussions, I think this is healthy. The important part for your listeners to know is we are not climate scientists, we do not study climate change. What we look at is the risk that severe weather events create for the economy, the payments system, which is in our core missions, and the financial system. We think about how are those things going to affect the world today, but also the world five and 10 years from now. Because ultimately, we have to be a forward looking Federal Reserve, we have to do our work so that we understand the risks around us so that we can fully achieve the mandates we've been given by Congress, and that's why we work on these topics.

BRIAN CHEUNG: All right well Federal Reserve Bank of San Francisco President Mary Daly, thank you so much for joining us here on Yahoo Finance today.