The Future of the Fed, Trump Style

BLOG VIEW: As he has with most of his appointments since taking office, President Trump has gone out of the norm with his choice to head the Federal Reserve, selecting Jerome Powell, the first non-economist nominated to the post since G. William Miller served the Carter administration in 1978–79.

Now that Powell is officially chairman of the Federal Reserve, we’ll have to wait and see whether the lawyer and investment banker will leave well enough alone or if he re-shapes the future of the nation’s central bank.

At least in the short term, the answer appears to be a sticking with the status quo, according to analysts who closely watch the Fed and its decisions on monetary policy.

“Given that the economy is running as well as it is at the moment, conventional wisdom would be to stay the course at the Federal Reserve, and in fact, President Trump appears to have considered leaving Janet Yellen in her position as Fed chair,” says Rick Sharga, executive vice president at Ten-X, the online real estate marketplace.

“It seems likely that Powell, who has served on the Fed’s board of governors and who has a reputation for being a centrist on economic policy, will continue to largely pursue the programs put in place by his predecessor,” Sharga adds.

The Fed’s mandates

As the nation’s central banking system, the Federal Reserve is accountable to the American public and to the U.S. Congress, which created it through the Federal Reserve Act of 1913.

Considered an independent government agency, the Fed has to fulfill mandates specified by Congress. Key among those: conducting the nation’s monetary policy and promoting maximum employment, keeping prices stable, and moderating long-term interest rates. It’s also tasked with promoting the stability of the nation’s financial system, the safety and soundness of individual financial institutions, and consumer protection and community development.

Most recently, under the leadership of Ben Bernanke and then Yellen (the first female chair in the central bank’s 100-year history), the Fed brought the nation’s economy back from the dead following the Great Recession through three rounds of quantitative easing. The Fed purchased $4.5 trillion in securities in all, which in effect put more money into circulation and lowered interest rates.

“The concept behind quantitative easing was to create more resources for the financial system, making the banks freer to lend and the public more apt to borrow,” says Chris Muoio, senior quantitative strategist for Ten-X Research.

Yellen officially ended that program in October 2017, and now the Fed is seeking to repair its balance sheet under new management.

The Fed with Powell at the helm

Although not an economist by profession, Powell has served on the Fed board since 2012 and was a visiting scholar at the Bipartisan Policy Center in Washington D.C., where he focused on federal and state fiscal issues. He also served as assistant secretary and as undersecretary of the Treasury under President George H.W. Bush.

So with the economy on the mend thanks to continued low unemployment and interest rates, and inflation seemingly in check for the moment, will Powell continue on the roadmap set by his predecessors, or will he change direction and set a new course of his own?

The consensus appears to be that he’ll continue to navigate along the course already set. Powell is known as a centrist who generally votes with the majority.

“Overall, what’s important for the economy is that there is a lot of continuity between a Yellen-led Fed and a Powell-led Fed,” says Ryan Sweet, director of monetary policy research at Moody’s Analytics. “He’s not going to want to rock the boat too much, at least not early in his years. Right now, it’s on auto-pilot.”

For the most part, Powell’s decisions regarding monetary policy have been in line with Yellen’s, although he seems to favor more bank deregulation than his predecessor did. Basically he’s viewed as more neutral, but with a Republican spin on what Yellen has done in the job.

“Powell looks a lot like Yellen in his approach to things,” says Christopher Thornberg, principal of Beacon Economics. “The reality is the Fed’s doing a fine job. There are some basic realities they can’t influence. He understands what he can and what he can’t do.”

One thing Powell did address during his confirmation hearings was his desire to lessen the range of regulation espoused in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, particularly as it applies to smaller financial institutions – making it easier for them to lend money.

“Dodd-Frank went too far,” says Thornberg. “There is a happy medium. How much is the operative question. Some is good … too much is a problem.”

Muoio agrees with Sweet and Thornberg when it comes to Powell’s influence on the Fed.

“I don’t think we will see much of a shift in terms of monetary policy,” Muoio says. “Based on his initial comments, Powell seems to be set to follow the path Yellen has set forth. This could always change once he officially assumes the position, but I don’t expect it to.

“My guess is that most of the change at the Fed will come in the form of a more lax regulatory stance,” Muoio adds. “I would expect the Fed governors will fall into this mold, although it’s uncertain who they will be. I would expect the stress tests to be relaxed as well, but monetary policy will likely stay on track.”

In the short term

While Congress will most likely not let President Trump have his way with taking power away from the Fed, the president can have a significant impact depending on whom he appoints to fill the four current vacancies on the Fed’s board of governors.

Until that time, Sweet believes the real test Powell is going to face when taking the helm at the Fed will be communications, which is something that Yellen has proven to be very good at.

“The Fed has one idea of where interest rates are headed, and the financial markets have a different view,” Sweet says. “He has to close the gap, and he has to do it gracefully.

“The stock market has been on a tear. There is a correction coming at some point, and how Powell handles that is going to be important in assessing how much emphasis he puts on cushioning financial markets. In the past, if there was any significant hiccup, the Fed swooped in and saved the day. That’s not going to be happening in the future.”

Sweet believes that Powell hit “all the right notes” during his confirmation hearing, but he will still face a learning curve in office.

“From a communications perspective, he’ll figure it out pretty quickly,” Sweet says. “The biggest test will be when the economy goes into the next recession. Interest rates will likely go back to zero, and he’ll have to think outside the box.”

Sweet believes that the passage of Trump’s tax bill will lead to a stronger gross domestic product, along with higher inflation, exceeding the Fed’s target for inflation in 2019.

“That’s not the end of the world,” Sweet says about inflation. “It’s been too low for too long. There are some economic benefits to higher inflation.”

Over the short term, Sweet forecasts a boom/bust cycle in the economy, with strong GDP growth through 2019 before another recessionary period hits sometime in 2020.

In the meantime, the Federal Open Market Committee in December unanimously voted to raise its primary credit rate by 0.25% to 2%. Depending on how well the economy does in the near term, some experts predict that the Fed may raise interest rates as many as four more times in 2018.

Joel Cone is a blogger for Smarter Investor. His articles have appeared in California Real Estate magazine, OC Metro, GlobeSt.com and The Los Angeles Daily Journal. You can follow him on Twitter and LinkedIn. He is also a contributor to Ten-X.

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