Make the Fed Cut Again
In April 2019, I discussed President Trump’s impact on the Federal Reserve in a blog piece entitled Moore rate cuts or a world of Cain. Despite the self-proclaimed catchy title, neither of the nominees that had been backed by the White House last spring (Stephen Moore and Herman Cain) were able to survive the Senate approval process and join of the Board of Governors. Instead, Moore and Cain’s names were added to the growing list of failed nominees during the Trump Presidency including Nellie Liang and Marvin Goodfriend.
Currently two seats on the Board remain vacant despite the fact that the President has a Republican majority in the Senate and a vocal opinion about Fed policy. Since the 2016 election, President Trump has had the incredible opportunity to appoint five new individuals to the seven member Board of Governors that make up the permanent voting members of the FOMC as well as appointing the Chair. Such an opportunity has rarely been available to a President so quickly into a first term. Nevertheless here we are, again, trying to fill these vacancies with two new names in 2020: Judy Shelton and Christopher Waller.
While both candidates appear to have a bias for lower interest rates to support growth and a skepticism about the Phillips Curve relationship between inflation and unemployment, the differences between the two candidates are more meaningful. Waller comes from within the Federal Reserve System and works for President Bullard of the St Louis Fed. President Bullard is currently one of the more dovish members of the FOMC and has also made comments more recently suggesting an interest in leading the Fed as Chair in the future. Judy Shelton is an outsider at the Fed. At a recent Senate Banking Committee hearing, she was criticized due to a lack of consistency regarding her economic views over time. Focusing on some of her more recent comments, her agenda appears focused on cutting interest rates and setting monetary policy as easy as needed to explicitly promote Trump’s pro-growth agenda. She has also mentioned devaluing the US dollar to compete against other nations as well as the removal of interest on excess reserves (IOER). She has also historically supported initiatives such as the Sound Money Project and other gold standard offshoots.
Stepping back and looking at the big picture, even if Shelton and Waller are both approved by the Senate and are able to join the Board, the establishment within the Fed and those leading the FOMC (namely Chair Powell and Vice Chair Clarida) will not be swayed by one or two loud voices even within their own ranks. Not to mention, Judy Shelton appears to already be facing tough opposition and is speculated to not have much of a chance of being approved. On the other hand, if Shelton and Waller are approved they would be on the fast track for the Chair position in 2020. Which brings me to key focus of this blog.
While Board of Governor appointments may seem like small potatoes, in a potential Trump re-election his choices could have an exponentially larger impact on the Federal Reserve. Although President Trump has been off to a slow and somewhat predictable start by filling Fed vacancies with relatively establishment candidates (Clarida, Quarles, Bowman as well as Powell as Chair), things could change considerably in a second term. While the market often describes an election outcome where Trump wins a second term as “status-quo”, the impact on the Fed may be anything but. The markets have put a lot of emphasis on the Fed’s policy review concluding in mid-year, however this policy review is only as impactful as the current Chair makes it. Like every Fed chair, the next Chair in 2022 will drive policy with their own style and biases which may or may not align with the new policy framework decided mid-year.
The strategy President Trump used for his first four successful choices for the Fed of choosing establishment-like resumes with a Republican tilt may no longer be the same criteria he uses to choose the next Chair in 2022. His frequent criticisms of Chair Powell as well as the shift in the type of nominees he is bringing forward for the Board would suggest that Trump’s strategy has already changed. President Trump’s recent choices to fill the remaining seats within the FOMC have become more controversial over time either due to their blatant allegiance to the President, lack of traditional experience, unorthodox economic believes or most fundamentally a belief that current monetary policy should be more accommodative.
Financial markets have been thrown many curve balls in this cycle. Despite heightened uncertainty, the markets thus far have taken most everything in stride supported by the US consumer that keeps everyone going. Nevertheless, a crisis of confidence over the steady hand at the Fed is an untested challenge for market participants which have grown accustomed to over-communicating academics and well-telegraphed monetary policy shifts.
While no one knows for certain what 2020 or 2022 will bring to the White House and subsequently to the Eccles building, staffing changes and increasing political pressure within the Fed is a near-certainty. Looking forward, watch the senate`s conversations on the nomination closely because if Shelton and Waller are approved for positions speculation will quickly build in the market about who the next Chair will be under a Trump re-election.