By Thomas Hollenberg
Capital Group Fixed Income Investment Analyst
Current Federal Reserve Governor Jerome Powell will be the central bank’s next chair, if confirmed by Congress. President Donald Trump announced the nomination, which had been widely expected by the market. Powell taking over the role of chair may mean some changes on the margin, but overall, I expect a continuation of steady and predictable Fed leadership.
Powell would take over leadership of the Fed at a crucial time. The central bank’s unwinding of historically unprecedented monetary stimulus and intervention, in response to the 2008 financial crisis and recession that followed, is now well underway. The new chair will have a significant impact on whether the Fed follows its current projections for hiking rates, moves more aggressively to raise them, or softens its stance to keep rates lower for longer.
However, in keeping with recent tradition, Powell has never cast a dissenting vote on a policy decision since joining the board in May 2012. He values consensus building, saying in a speech earlier this year: “In my experience, the best outcomes are reached when opposing viewpoints are clearly and strongly presented before decisions are made.”
In context of the persistently low inflation we have seen so far in 2017, Powell noted in August that the Fed has the “ability to be a little bit patient” on hiking rates. That sentiment implies he won’t be eager to take much more of a hawkish tone than his predecessor. As a result, I expect little change in the market’s rate path for 2018, which implies hikes amounting to about 40 basis points, or roughly 1.5 hikes of 25 basis points each.
The Fed began tapering its reinvestments in maturing securities in October, toward a goal of gradually reducing its $4.5 trillion balance sheet. However, one sticking point in its runoff plan is that it hasn’t published a firm number for what its final balance sheet size should be.
That omission created a risk that an incoming Fed chair might have pushed to cut the balance sheet back to its much smaller, pre-crisis size of under $1 trillion. Such a strategy would likely shock asset prices. In June, however, Powell gave a speech lending support to a terminal balance sheet of around $3 trillion, more or less in line with market expectations. If he does stick to the perceived plan, bond yields should feel little additional impact.
Powell is more comfortable with new regulations imposed by 2010’s Dodd-Frank Wall Street Reform and Consumer Protection Act than some other candidates Trump was considering. However, he may be more open to shuttering financial rules than current Chair Janet Yellen. He has spoken in favor of simplifying many moving parts affecting banks: stress tests, the Volcker Rule and rules that affect small banks.
Powell’s private-sector background may make him more sensitive to the Fed’s policymaking impact on business. He has also worked alongside the newest Fed Board member in charge of supervision, Randal Quarles, at The Carlyle Group. With regard to the topics Powell has addressed in speeches this year, you can see he has placed more emphasis on the machinations of the financial system (banks, market and payments) than Yellen. This has the potential to lead to a modest pickup in lending activity and economic growth.
Powell was nominated to the Fed in 2012 by President Barack Obama. A Georgetown-educated lawyer, Powell does not have the academic economist background found on the resumes of other recent Fed chairs. Instead, his experience is largely in the private sector.
After practicing briefly as a lawyer, he spent several years as an investment banker with Dillon, Read & Co. He had a brief stint in George H.W. Bush’s Treasury in the early 1990s, eventually becoming Under Secretary for Domestic Finance. From there, he moved back to banking, eventually landing at The Carlyle Group where for several years he focused on industrial buyouts. Before joining the Fed he also worked in private equity and venture capital.
The state of the U.S. economy will loom large in the Fed’s this decision making. While the nation’s growth continues to proceed at a moderate pace, if it picks up further leading to higher inflation, the Fed’s monetary policymakers may seek to tighten policy more aggressively. However, if the economy is in the late part of its cycle, as many economists believe it to be, then a fresh dose of monetary stimulus could be employed.
Monetary policy decisions are also more complicated than they have been in the past, due to possible structural changes occurring in the U.S. economy because of demographics and other factors. Right now, for example, the U.S. unemployment rate is extremely low at 4.1% 4.2% – the lowest since 2000. Yet that statistic is clouded by historically low labor force participation, which could be an indication of additional slack that the prevailing statistic does not take into account.
Meanwhile, inflation – the other major indicator that the Fed relies on for monetary policy decisions – continues to lag the central bank’s 2% target, even as the economy grows at a healthy rate. This disparity makes a more aggressive tightening campaign by the Fed harder to justify.
The Fed in 2018 is also poised to look much different than it did at the start of 2017. Even if Powell is confirmed, President Trump has at least three additional seats to fill on the board in addition to the one seat he has already filled with Quarles. This would increases to four if, as expected, Yellen steps down after Powell takes over the chair. It will be up to Powell to steer a much different group toward consensus.
The U.S. central bank also plays an important role in the world economy, as its policies impact not only Americans, but economies in other countries as well, given the prominent role the U.S. plays in global markets.
Developed economies seem to be entering a more synchronized phase of monetary tightening. On October 26, the European Central Bank announced that it would begin to taper its asset purchase program, cutting purchases in half starting next year. The Bank of England raised its policy rate on November 2 for the first time in a decade after third-quarter U.K. growth came in higher than expected. Despite these moves, however, central bank balance sheets are expected to continue to grow in aggregate for developed economies.
As other major central banks begin to drain money supply, the impact on global financial markets of any Fed action becomes even more significant. This could make the world economy still more sensitive to the new chair’s influence. However, since Powell’s leadership is likely to leave the Fed largely on its current course, the market is likely to view his chairmanship as a stable presence.
Tom Hollenberg has research responsibility for interest rates. He has 11 years of investment experience and joined Capital in 2016. He holds an MBA from MIT and a BA from Boston College.