First, we suggest reading this February 24, 2017, note in the Washington Post by Neil Howe: washingtonpost.com/entertainment/books/where-did-steve-bannon-get-his-worldview-from-my-book/, since the following discusses a “turning” that may be approaching with the central bank of the United States. We may get an early taste tonight.
To set the stage for a discussion of the Trump Fed, let’s also open with a news item. The status of the President’s Council of Economic Advisers (CEA) has been downgraded by the Trump administration. See wsj.com/articles/donald-trumps-cabinet-wont-include-chairman-of-cea and politico.com/story/2017/02/kevin-hassett-council-of-economic-advisers-trump. Meanwhile, it has become pretty apparent that critics are not welcome in the White House and that academic thinking is not to be favored in the Trump economic policy debate. In our view that means a rising risk is developing in the making of monetary policy.
Will President Trump repeat the error made by President Carter when he appointed William Miller as Fed Chairman in 1978? Do the folks who have the President’s ear on the economic front share his bias toward the use of debt to finance real estate and sympathize with his habit of neglecting personal guarantees and discharging debt through bankruptcy?
Remember that handling a debt burden is easier under an easy-money policy that allows some inflation to soften your debt burden. This is especially true when your debt carries low nominal interest rates that have been placed during a time when inflation expectations were low or falling. Trump starts out after a 36-year period of falling rates and declining inflation expectations. Readers may recall that when Paul Volcker followed William Miller as Fed chair, the inflation rate was around 10%, and interest rates were well into the double digits.
Let’s take a guess at the Trump Fed next year (2018), using what we know and assuming that Trump follows the pattern of replacing existing folks as he has elsewhere.
Here is the potential Fed voting lineup for the middle of next year. Please remember, this is speculative.
• Fed chair – Trump selects. Yellen completes her chair term in February 2018 and (we guess) does not stay on as a governor.
• Fed vice-chair – Trump selects. Fischer completes his term in June 2018 and (we guess) does not stay on as a governor.
• Fed governor existing vacancy – Trump selects
• Fed governor second existing vacancy – Trump selects.
• Fed Governor Tarullo resignation seat (he has resigned effective April 2017) – Trump selects
• Governor Brainard. She publicly supported Hilary Clinton with a political contribution. Does she resign or serve out her term? Does Trump select?
• Governor Powell is currently viewed positively in the world financial community and is carrying no obvious political baggage.
• NY Fed President Bill Dudley is the only Fed president who is a permanent voter on the Federal Open Market Committee.
• The Atlanta Fed will be voting. A new president will occupy that seat.
• San Francisco Fed President Williams will be voting.
• Cleveland Fed President Mester will be voting.
• The Richmond Fed will be voting. A new president will have replaced Jeff Lacker, who is the longest-serving existing president and FOMC member.
In 2018, we may have a Fed where only four of twelve voters will be veterans. Seven other regional Federal Reserve Bank presidents will be FOMC members but nonvoting in 2018 due to the Fed’s voting rotation rules.
The perennial questions for market agents are “Who will make monetary policy at the Fed” and then “What will it look like?” The “who” can help define the “what.” Right now we can only surmise. But please note how few of the probable decision makers will have actually experienced the US financial crisis years of 2007–2009 in a policy-setting role.
Right now, markets seem to be avoiding any pricing of this Fed-appointment risk. Markets for US Treasury securities seem unpressured, and yields have backed off from their highs. The US currency seems biased toward more strength. The US stock markets are at or near all-time highs. And all Trump political rhetoric is aimed at more growth and lower taxes with fiscal stimulus and infrastructure rebuilding.
At Cumberland, we see a need to be more nimble. Portfolio activism requires changing durations in bond accounts. We see early-stage risks rising. We think the 36-year decline in interest rates is over and the low point was reached following the Brexit vote last year. That is reason to emphasize stronger credit work and not to rely on the long stretch of declining interest rates and falling inflation expectations to continue to provide “a wind at our backs.” Some cash reserves may be appropriate in the stock market, and sector changes remain important.
Political talk about the Fed is now a critical item to watch. We believe that a “turning” may be at hand.
