On Monetary Policy, Much Ado (Sep. 20)

In a press conference this afternoon, Federal Reserve Chair Yellen announced no surprises.  The Fed will maintain a federal funds target rate of 1 to 1.25 percent.  Yellen described inflation levels below the central bank’s two percent target.  She reiterated the Fed would reduce its balance sheet holdings predictably and gradually and that we will see a rate hike of 25 points in December and three more such hikes next year.

The Fed’s statement today is nearly verbatim identical to its last iteration, with a brief assurance that price spikes from this season’s explosive hurricanes will be temporary. But the news is in the details and below we explore what the data and the Fed say about the trajectory of monetary policy and the Fed’s balance sheet normalization process — and what sources say, or speculate, about succession at the helm of the Fed.

Best,

Dana

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Yellen today confirmed that the federal funds rate target range from 1-1.25 percent will remain unchanged once again, and that further  reduction of the balance sheet will occur in October. Under its asset sales plan, the Fed will be receiving monthly payments of up to $30 billion for its maturing Treasury securities, and $20 billion per month for its mortgage-backed securities, 12 months into the plan.

Yellen called this process of normalization necessary for the Fed, and timely. Inflation has been well below two percent this year.  It is 1.6 percent now and is expected to rise to 1.9 percent next year. This increase should be accompanied by higher interest rates and a more stable economy.  It does not impel the Fed to accelerate its planned series of rate hikes.

Labor market statistics of late offer reasons for optimism.  Unemployment remains historically way down and household incomes coming are up. Additionally, labor force participation has clearly stabilized. Over the last three years, the range of the leading participation metric has been within 62.4 and 63.0 percent. The end of the Obama years did not see a hemorrhaging of the labor force — a persistent refrain from critics — despite the aging population. The Obama years saw the labor market size stabilize, this despite large and increasing numbers of Baby Boomers retiring.  Confounding then is why, with these positive labor market figures, wages are barely moving.

Yellen admitted that analysts were unsure how to explain the sluggish core inflation rate, but pointed out that temporary inflation dampeners might be source of some of the lag. She defended the Fed’s rate hike plan, arguing that, little remaining slack in the labor market and the typical wage-price inflation lag, inflation is likely to increase next year to reflect strong job growth.

With the GOP on the Hill unwilling for years to approve fiscal policy measures to combat the recession and stimulate the recovery, that recovery came to depend on the Fed to use its monetary policy authority creatively and aggressively — which it did to enormously beneficial effect. But when the economy was desperate for stimulus, the GOP leadership in Congress used debt  brinksmanship to push through the rather contractionary 2011 Budget Control Act.

As yesterday’s reports of deficit-negative budget bills in the Senate might suggest, Republicans’ austerity fever may have broken now, or for now, with visions of major tax cuts in the offing. But gone is the day when the Fed will take guidance from Congress or the President or compensate for policies badly designed for current economic conditions.

Speaking of the President, while his views on monetary policy, the Fed, and his upcoming appointments to it are more reported than known, they will become much better known fairly soon. As NEC Director Gary Cohn’s diminished chance of being appointed Fed Chair after Yellen’s term is up in four months, a new contender has emerged. Banker Kevin Warsh appears the most likely alternative to Yellen at present. Warsh was one of the youngest Federal Reserve Board Governors from 2006 to 2011. His views favoring broad  financial de-regulation clash with those of the Yellen Fed majority.

But Warsh has criticized low interest rates. The King of Debt probably doesn’t want it made too expensive. It is not beyond the pale that Janet Yellen may be re-appointed Chair.

The President praised Yellen earlier this year for being “a low interest rate person.” It stands to reason that President Trump would favor her slow and measured approach to raising interest rates.  That’s one reason it’s hard to predict his stance.

With four central bank Governor vacancies out of seven seats to fill after Vice-Chair Fischer’s coming retirement next month, Trump has the opportunity to shape monetary policy for years to come. With a majority of Trump-appointed Federal Reserve Board likely by early next year and Trump’s presumed preference for accommodative policy, you would expect a howl from the bond vigilantes if his nominees seem bent on economic growth.

We will find out in short order.  Trump’s first nominee cleared the Senate Banking Committee two weeks ago and is headed for a floor vote. We await the appointment of three more nominees, along with Trump’s determination on the Chair and Vice-Chair positions. Though, curiously, Yellen did mention during the press conference that the Board could function with only three Governors — three incumbents, that is.