After four years as Federal Reserve chair, Janet Yellen makes her swansong at this week’s monetary policy meeting (no disrespect to Ms. Yellen, but it seems like a lot longer, doesn’t it?), at which time she will likely welcome her successor, Jerome Powell, who was finally confirmed by the Senate. Her term officially ends on February 3, at which time she has said she would also step down from the Fed’s Board of Governors, where she was entitled to remain for another six years.
While most observers believe Powell won’t deviate too far from the dovish, don’t-rock-the-boat policies of his predecessor, I think he’s likely to be a little more hawkish in raising interest rates, if for no other reason than to skim some of the froth from the stock market. Another quarter-point increase in the federal funds rate at next week’s meeting would be a good signal about what to expect from the Powell Fed going forward.
I’m still not entirely sold that inflation won’t at some point in the future rear its ugly head once again, mandating a more aggressive interest rate-raising policy, but the bond market – based on still relatively low long-term Treasury bond rates – apparently has yet to be convinced. Still, inflation, whether just boiling under the surface or several years down the road, isn’t the only reason the Fed needs to be more hawkish. Taking some air out of asset bubbles – whether they be in old-fashioned equities or yet-to-be-tested cybercurrencies – that has primarily been the result of the Fed’s overly accommodative monetary policies is a good enough reason to do so.
While Yellen could justify keeping rates too low for too long because the economy was arguably too weak to sustain higher rates, Powell probably won’t have that excuse. With the economy now growing at a 3% annual pace, and likely to get stronger under tax reform, it should easily swallow higher rates without throwing the economy off kilter.
Higher rates will likely attract some investment money out of stocks and into bonds, which should not only lower stock market returns to more reasonable and sustainable levels but also moderate any potential spike in bond yields.
Blessedly, Powell – who goes by the less formal Jay – comes to the Fed with real-world financial experience, not from an academic ivory tower. He will be the first Fed chair in three decades without a Ph.D. in economics. A lawyer by training, Powell worked for six years as an investment banker before going into government service under the first President Bush, then back to Wall Street and the private equity world. Before being nominated to the Fed by President Obama in 2011, he was a visiting scholar at the Bipartisan Policy Center, a Washington think tank.
According to transcripts of monetary policy meetings released by the Fed earlier this month, Powell expressed skepticism about some of the central bank’s more controversial and unorthodox strategies, namely its unprecedented bond-buying program in 2012, when the Fed’s balance sheet swelled from an already heady $2.8 trillion to more than $4.5 trillion in a little more than two years. It still stands close to that figure even now, ten years after the financial crisis.
“There is no credible threat of deflation, recession or financial crisis, any of which could present a compelling case for action and the use of all of our tools,” Powell said back then. “Why stop at $4 trillion? The market in most cases will cheer us for doing more. Our models will always tell us that we are helping the economy, and I will probably always feel that those benefits are overestimated.”
Nevertheless, Powell went along with the program, albeit “with a certain lack of enthusiasm,” adding that he was “somewhat uncomfortable with the road that we are on.” At that time, the unemployment rate was over 8%, but trending downward.
“My concern is that for very modest benefits, we are piling up risks for the future and that it could become habit forming,” he said, presciently. The Fed didn’t stop at $4 trillion, and the markets have yet to stop cheering.
Which is where we find ourselves today. Indeed, reducing the size of that balance sheet, whether through attrition or outright selling, is likely to prove a lot trickier to accomplish than merely raising interest rates a quarter point every three months or so. As Powell himself said six years ago, Fed officials were “way too confident” they could slow or unwind those bond purchases once they were ready to do so. We’re about to find out what happens next.
So while it may appear that Powell assumes the Fed mantle at an auspicious time, with the economy nearly fully-healed from the financial crisis, unemployment – at least according to how the Labor Department measures it – at an all-time low, and global stock markets at all-time highs, the fact is that a lot can go wrong if the Great Unwinding is not handled correctly. The new Fed chair may well find himself trying to clean up a monumental mess from a policy that he didn’t fully support in the first place.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.