The nomination of Jerome H. Powell as the new Federal Reserve Chair marks the end of an unusually public selection process. This provided market participants with the unique opportunity to debate various contenders’ strengths and weaknesses, and enabled the market to ultimately treat the selection of the final candidate as a “non-event” – a positive approach, as markets do not appreciate surprises.
Initially, Powell was marked as a bit of an unknown, as like most governors, he never voted against the Chair and so his personal views were unclear. But comfort was derived from the fact that he has been involved in all of the Fed’s current deliberations, and so a continuation of the Fed’s current slow and steady approach was seen as the most likely scenario.
Most would agree that the best marker of monetary policy success is a continuation of price stability; that is usually the gold standard test. Yet there are certainly many ways for policy makers to derail an economy. Avoiding escalation of price levels (high inflation) is certainly top of our list of the most desirable policy outcomes, as low inflation is generally positive for continued economic prosperity and beneficial for markets.
Some might wonder if FOMC actions have actually mattered on this front. Many market watchers argue that much of the current outlook for inflation has little to do with monetary policy. These arguments relate to technology’s ability to relentlessly drive down costs coupled with the forces of globalization, which continue to seek out lowest cost producers. These are useful perspectives to bear in mind, especially as a reminder that there are many forces outside of the Fed’s own reach.
Witness the Fed’s continued conundrum over the failure of inflation to reach as high as their desired 2% level, in spite of a decade of aggressive monetary accommodation. This alone raises questions about both the effectiveness and the complicated transmission mechanisms of desired central bank policy.
Policy always operates with a delay, and the timing and magnitude of the lag is variable. Pushing and pulling interest rate levers truly impacts consumer and business choices – eventually. But the impact is always a little uncertain, and the link to changes in demand for goods and services can be difficult to interpret.
We have been in a post-crisis sluggish recovery for about a decade, seeking that elusive pop of economic growth above 2%. Just recently, we have experienced two straight quarters of 3% growth, accompanied by commensurate stock market performance. There is much cheering on the sidelines from market participants for all of this to continue. Yet the Fed’s assignment, as always described, is to take away the punch bowl before the party really gets too out of control.
With all of that in mind, it’s almost a given that policy will, at some point, tighten too much. Powell agrees with incumbent Yellen that the level of interest rates going forward will be lower than what was seen as a neutral rate policy in past years. We just do not know how much lower and how small the changes might be before we arrive at the point where a bit of Fed engineered snugging was too much.
Even before that point, we will have to begin addressing the large Federal Reserve balance sheet. Dealing with that is both an important and uncertain assignment, and also unlike anything the Fed has ever had to do before. While the Fed has transmitted its desire to begin unwinding its vast mortgage-backed and Treasure holdings, that process has only just started. Decisions about how much to pare back and how quickly to do so will be essential elements on the direction of interest rate policy and an initial test for our new Fed Chair.
It is worth noting that there are seven seats on the Federal Reserve Board of Governors, and an anticipated four of those seats will open up (assuming Yellen is likely to leave). Her term as a governor is not affected by being replaced as chair, but we do not expect her to stay on. After five years on the Board, Powell is seen as a team player and a consensus builder. This makes the fact that the team will be changing significantly more interesting. Much like the process that led to Powell’s selection, we can only hope the market ultimately treats these new appointments as “non-events”, signifying a continuation of current policy.
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