Fed: An Even More Dovish FOMC

Published on July 3, 2019

After months of relentless attacks on Federal Reserve Chairman Jerome Powell and the earlier failed nominations of Stephen Moore and Herman Cain, President Trump’s intended nomination of Fed critic Judy Shelton and Chris Waller, the head of research at the Federal Reserve Bank of St. Louis, will firmly tip the scales to a strongly dovish lean within the Federal Open Market Committee, probably well into 2021.

*** Waller is very close in his thinking to St. Louis Fed President James Bullard and is likely to align with Bullard and Vice Chairman Richard Clarida in bringing an additional intellectual heft to the arguments for a near term “insurance” rate cut. Paradoxically, however, unless the data worsens in the next few weeks, we suspect the looming arrival of two clear doves will implicitly add to the case for a 25 basis point cut at the July 30-31 FOMC meeting over a 50bp cut. ***

Likely Confirmations by September

Barring an unforeseen turn in the last of their vetting, both Waller and Shelton seem certain to be confirmed by the Senate. We would expect their first FOMC meeting could come as early as September, though it may take even longer into the turn of the year, the Senate slow workings being what they are these days.

We think it almost inconceivable Senate Majority Leader Mitch McConnell and Senate Banking Committee Chairman Mike Crapo could somehow manage to rush the Waller and Shelton confirmation hearings and Senate floor vote in time for the FOMC July 30-31 meeting.

Shelton’s politically colored views — arguing for immediate rate cuts, questioning the Fed’s twin mandate, or taking a shot at the currency impact of “additional stimulus measures by other central banks” — make her the ideal Fed governor for this White House.

Her long record of unorthodox views, calling until recently for a return to the gold standard or warning of looming hyperinflation due to excessively accommodative Fed policies, at least before the 2016 elections, may make her a target for sharp questioning in her Senate hearings. But is hard to see her appointment to the Board being derailed in a Republican-controlled Senate.

Shelton was already easily confirmed by voice vote when she was named to the European Bank for Reconstruction and Development a few years ago. But that said, her influence within the Board and the FOMC will be limited.

Waller Brings an Intellectual Heft to the Board

Waller, on the other hand, a macro-economist who has written extensively on the political economy, is likely to bring some intellectual heft to the Board that will add to the arguments currently being made by Vice Chairman Clarida and St. Louis President Bullard (see SGH 4/22/19, Fed: A Pre-emptive Rate Cut “Recalibration”).

Waller was brought to the St. Louis Fed by St. Louis Fed President Bullard to head up its research department in 2009. He and Bullard are very close in their thinking and approach, and have co-authored several monetary-policy research papers. Waller was on Bullard’s dissertation review committee when the St. Louis Fed president first earned his PhD in economics from the University of Indiana.

Waller himself earned his PhD in macroeconomics from the University of Washington under a dissertation advisor who was a student protege of Stanley Fischer when he taught at the University of Chicago. But like Bullard, Waller grew disenchanted years ago with the reliability of the Phillips Curve assumptions of trade-offs between the labor market and inflation, while also being influenced by the secular stagnation thesis presented around the same time by Harvard University’s Lawrence Summers.

By 2016, with a contribution from Waller, Bullard unveiled a new “regime shift” based forecasting model for the St. Louis Fed’s contribution to the FOMC’s Summary of Economic Projections and rate dot plots. Ever since, Bullard has argued for a largely demographic-driven, very persistently low and inertial inflation regime that would only shift upward with a low probability lift in productivity.

Waller, while differing on some aspects, shares Bullard’s views on a persistently low inflation that is keeping the short-run r* at and probably below the current 2.4% policy rate.  We would take Waller’s arrival at the Board, alongside Shelton, to comprise a very solid dovish lean to the Board of Governors.

Impact on the FOMC July Decision

Paradoxically, however, unless the data truly crumbles in the coming weeks, the looming arrival of two more policy doves to the Board may make a 25bp cut more likely than a 50bp at the FOMC’s July meeting.

As we are assuming Waller and Shelton won’t be confirmed until the fall at the earliest, and certainly not before the July FOMC meeting, we think the eventual arrival of two dovish-leaning Governors to the Board will make the September FOMC discussions potentially even more pivotal than we were previously thinking (see SGH 7/1/19, “Fed: The Run-up to the July Meeting”).

Unless data moving either sharply in either direction forces their hand, the FOMC may be by then weighing whether near term rate cuts are the start to a true easing cycle, or whether a likely rate cut in July would be only the first of a one or two rate cut “reset,” after which a still resilient expansion would put Fed policy back to an “in either direction” policy stance.

In making that decision, the FOMC, in effect, will have to weigh how comfortable they will be with lowering rates sooner or deeper with those rates then potentially staying in place for the next several years.

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