The statement issued by the Federal Open Market Committee at the end of their two day meeting this afternoon was as anti-climatic as could be expected in its steady as it goes descriptive phrasing and tone.
The growth outlook was upgraded here and there, and there was a new concession that core inflation remained “soft;” but the main messaging signal for the highly likely rate hike in December was probably the repeat affirmation that “the stance of monetary policy remains accommodative.”
*** The far larger story for the Fed, obviously, will come with the end to the weeks-long Fed appointment drama tomorrow afternoon, when President Trump is expected to formally announce that Fed Governor Jerome Powell is his choice to succeed Janet Yellen as the Chair of the Federal Reserve. Yellen is likely to join Powell at the White House press conference, set for 3pm tomorrow. ***
*** Looking forward, we do not expect any significant change in the current base case policy path, starting with a rate hike this December and, assuming data through the first half of next year adheres to the forecast path, followed by at least two more rate hikes, probably no later than next September, to lift the policy rate to a presumed neutral rate at or near 2% nominal. ***
*** In other words, Powell is already aligned with a rate trajectory far more hawkish than anything the market is pricing. And yet to come is whether the Fed will be factoring into the appropriate rate path a net fiscal stimulus of some scale in any tax cuts and deficit spending the President and Republicans on Capitol Hill can manage to pull together. Low inflation notwithstanding, it is fair to say, the rate risks are to the upside. ***
Powell at the Helm
Not too long after Vice Chair Stan Fischer announced his stepping down from the Board of Governors in September, serious consideration was given in the White House Fed discussions for a twin nomination of both the Chair and Vice Chair. The leading pairing at that moment was of Stanford University’s John Taylor as Chair, and Powell as the Vice Chair (see SGH 10/13/17, “Fed: A Taylor-Powell Leadership Era”), which the President then confirmed was indeed being weighed a few days later.
But we understand that about the only person in the room favoring Taylor in those meetings was the President himself, with most of the advisors, especially Treasury Secretary Steven Mnuchin, making the case for Powell. The absence of any market or political pushback to the repeated trial balloons floating Powell’s name in the media through the last few days has been telling. And for a President who may have a knack for unpredictability on most matters, he is not likely to rattle the markets with a bait and switch to a different candidate. So the Powell nomination would seem to be a sealed deal.
In fact, Powell made a highly favorable impression on the President at their first sit down meeting early in the White House Fed vetting process (SGH 9/6/17, “Fed: Succession Scenarios”). Powell, in fact, has been just about everyone’s favored second choice in the sense of offering a desired balance in a continuation of Chair Yellen’s gradual pace of rising rates, and a (modestly) easier stance on the Fed’s interpretations of the Dodd Frank rules and regulatory oversight.
We doubt as Chair that Powell will press too far for an unwind of the Dodd Frank rules on the big banks, especially when it comes to capital and leverage ratios. Indeed, one aspect of the Powell leadership may be how financial stability may increasingly enter into the Fed’s policy messaging. Fed Chairs are traditionally loathe to pin too much of the rate policy decision-making on the financial stability question, preferring instead to approach the issue strictly within the existing twin mandate for employment and inflation.
But Powell is said to be among the FOMC members — and to a limited extent, Chair Yellen herself in recent months — who are increasingly sharing some of the concerns voiced by Kansas City’s Esther George and Boston’s Eric Rosengren on the potential destabilizing effects on financial stability in a prolonged period of low rates.
While the persistence of low inflation, and the “mystery” of this year’s unexpected inflation dynamics, has dominated the internal FOMC and public remarks through much of this year, we suspect more FOMC members, including Powell himself, may modestly and carefully nudge the financial stability question more to the forefront of the Fed policy decisions next year. The last two recessions, after all, came from financial market dislocations, not sharply higher interest rates to counter inflation.
At the margin, Powell as a non-economist may prove to be somewhat more beholden to the Board staff on monetary policy in comparison to Yellen or Bernanke, lacking their academic training in macro economics. On the other hand, Powell is said to have won strong staff support and respect due to an astute analytical grasp of staff work and policy issues, while his communication — and political — skills have become well honed.
He has likewise made an effort to reach out to the Districts, a key if relatively under-appreciated aspect of the Chair’s task in leaning to craft a consensus on policy decisions. He is well respected inside the Fed, and as a Republican, will be easily confirmed by the Senate without much fanfare.
The Board’s Changing of the Guard
Beyond tomorrow’s expected announcement, there are still two to three vacancies to fill on the Board of Governors. There is the Vice Chair slot still to fill, and the Governor’s slot made vacant by Powell’s presumed elevation to the Chair after Yellen’s final day next February 3. We would also wonder whether Governor Lael Brainard, who in her tenure became an influential dovish voice on the Committee, will be eyeing an exit at some point next year.
There was no small surge of speculation in the last few days of the Powell as Chair leaks that Stanford’s Taylor could still come on board as a Vice Chair under Powell, alongside Randal Quarles, the newly installed Vice Chair for Banking Supervision, who attended his first FOMC meeting this week.
While it is still possible Taylor could be offered, and accept a Vice Chair nomination, we suspect it is unlikely. The same doubts hold even more true for a selection of Kevin Warsh as the Administration’s Vice Chair nominee. Otherwise, the search process beyond the candidates already vetted for the Chair position is pretty much starting from scratch.
As more speculation than anything else, among the mostly academic candidates may be Columbia University’s Glenn Hubbard, Harvard’s Greg Mankiw, Boston College’s Peter Ireland, or Columbia’s Charles Calomiris. There was also some thought, several months ago at least, of perhaps naming a serving or former Fed district President to the Board, with the appeal largely coming in a permanent rather than rotating vote on the FOMC.
Otherwise, we have no reason to believe the nomination of Carnegie Mellon’s Marvin Goodfriend and Indiana’s Old National Bank Chairman and CEO Bob Jones will not be proceeding to Senate confirmation hearings and a floor vote, hopefully before year-end. We also still understand the Administration is considering an eventual nomination of Daivd Malpass, currently Treasury’s Undersecretary for International Affairs, to the Fed Board of Governors.
At this week’s FOMC meeting, there were only four Governors attending — Yellen, Powell, Brainard, and Quarles – and there may be only four governors attending the December meeting, unless the Senate can bring forward the Goodfriend and Jones confirmation floor votes amid the scramble to pass tax cuts and the FY2018 Continuing Resolution.
Assuming Powell can be confirmed before her last day on February 3, the March FOMC meeting will be his first as Chair.The Senate will also need to vote again to confirm Quarles to a new 14 year term before February 1, since his initial appointment was to fill the remaining months of a vacant Governor’s position.
In any case, by this time next year, it is likely to be a full seven member Board of Governors, all of whom have been named by the Trump White House. What impact that may have on the Fed rate policy path is more of a 2019 event than something for next year, where there is to be any politically-colored change in the policy picture at all.
Next Year, a New York Fed Succession
Perhaps a more important change in the FOMC may not be in the Board of Governors, but a potentially significant transition when the Federal Reserve Bank of New York President Bill Dudley will be stepping down some time late next year. The Trump White House had approached several prominent figures from Wall Street in the initial search for a new Fed Chair, none of whom agreed to the scrutiny or to seriously consider their name going into the mix.
The New York Fed, of course, has been under considerable public scrutiny ever since the 2008 financial crisis amid outcries of “regulatory capture,” so it may be hard to see a prominent Wall Street figure taking the helm of the powerful New York Fed. Last we looked, there are all sort of different classes of votes on the district bank’s Board of Directors, with most of the votes that count to be tallied among non-bankers.
In theory, the selection of the district bank presidents has been relatively opaque and left to each bank’s private sector Board of Directors, that is to say, independent of White House or Congressional politics. That, it has to be said, may not be possible next year in the selection of such a powerful District President and his or her permanent vote on the FOMC.
Not to look too far deeply down the road, but it may well be the case that by this time next year, when the New York Fed President’s position is being considered, the FOMC may need to decide on the terminal size of the “normalized” balance sheet.
A few hundred billion dollars will have been rolled out of the portfolio holdings by the end of next year, and it could be enough to enable Fed officials to move closer towards a key decision on whether to maintain the current floor system of managing the policy rate with abundant excess reserves, or to revert back to the pre-crisis scarce-reserves operating system. Those institutional decisions could factor into the final selection of the New York Fed President.