Thursday / March 21.
HomeMarketsFederal Reserve vacancies hand Trump leverage

Federal Reserve vacancies hand Trump leverage

Painting a relatively optimistic economic picture during Congressional testimony this week, Janet Yellen confirmed the Federal Reserve would raise interest rates gradually. It was clear in the sessions, though, that other factors would soon weigh on interest rates and markets. Fiscal policy could make the Fed more hawkish. Yet the political agenda of financial deregulation, coupled with President Donald Trump’s choices for several vacancies on the Fed’s board of governors could tilt it the other way.

The economic background for monetary policy is, if anything, a little firmer than it was at the last Federal Open Market Committee meeting at the end of January. The most recent employment data, especially for manufacturing, support the idea that the lengthy inventory correction that had depressed economic growth for several quarters is over. The new year purchasing manager surveys, order flow and temporary employment numbers have been positive. The Fed’s preferred inflation measure, the personal consumption deflator, has continued to edge up towards the Fed’s 2 per cent target.

The Fed will therefore remain on a slow tightening path, in spite of familiar factors that keep rates low overall, including weak productivity, demographics, high global savings and the impact of prudential regulations on balance sheets. As the Fed chair suggested, however, fiscal policy could have a significant influence on monetary policy and markets.

At more or less full employment, significant tax cuts and higher infrastructure and military spending that are not fully funded will probably cause the Fed to drop data dependency as its lodestone for a more strategic, possibly pre-emptive, policy approach.

Away from mainstream rate-setting considerations, financial deregulation is likely to become an important issue for bank stocks specifically, and financial stability more generally. Mr Trump’s recent executive order, instructing the Treasury secretary to come up with proposals to rewrite Dodd-Frank, will be contentious in Congress and at the Fed, which is highly sensitive to political pressure. Protagonists say they want to help smaller banks, relieve the finance industry of unnecessary compliance, and, as the president himself asserted, to get banks lending again.

The evidence that banks are not lending, however, does not stand up to scrutiny. Small businesses, represented in the National Federation of Independent Business survey, reported a surge in business optimism in the two months to January, and no evidence of credit starvation.

The Fed’s Senior Loan Office Survey continues to report relatively easy credit conditions. Commercial and industrial loans and consumer credit have been growing by 6.5-8.5 per cent at an annual rate since the post-crisis nadir in 2010. Mortgage lending has been softer, but in the long shadows of the financial crisis, that is hardly surprising, and reflects credit demand, not supply.

The danger is that simplifying parts of the Dodd-Frank rule book will become conflated with a political agenda that ends up undermining some of the main macroprudential progress made with regard to banks’ capital and liquidity requirements, and risk management and stress-testing practices.

Fed governor Daniel Tarullo, who recently announced that he planned to resign in April and was the Fed’s point-man on regulatory issues, presided over much of this agenda after his appointment in 2009. His departure has important implications for what happens to banking regulation, and for the Fed’s policy stance more generally.

1. Dollar climbs on hawkish Jackson Hole speech from Fed chair Janet Yellen

2. Trump wins election and promises to unite the US, sparking dollar rally

3. Robust data pushes dollar up to 13-year high

4. Federal Reserve raises interest rates

5. Trump’s combative pre-inauguration press conference sparks investor uncertainty

Mr Trump will now be able to nominate three new people to the seven-member board, since there were already two other vacancies. He has an even bigger chance to shape the Fed because the terms of both Mrs Yellen and vice-chairman Stanley Fischer end in 2018. They could stay on until their governorships expire in 2024 and 2020, respectively, but un-renominated officials traditionally step down. Mr Trump, therefore, could potentially name five new governors within the next year.

Predictability is not the president’s strong point, but he might well want a more dovish Fed, which he would find conducive to both managing debt-financed fiscal expansion, and realising a weaker US dollar. Former US president Ronald Reagan once thought early in his first term, with the US economy in recession, about placing the central bank under the authority of the Treasury secretary. He did not, but Mr Trump could simply create a more compliant Fed.

For now then, the monetary policy agenda looks relatively clear and economically determined. Before long, though, markets and the economy could be in for a rude shock if the Fed became an easy money subordinate to the government.

George Magnus is an economic consultant, and former chief economist at UBS

Source link