MNI Fed State of Play: Different Economy Could Test Powell Fed

By Jean Yung

     WASHINGTON (MNI) - Over the coming year, the three most influential seats

at the Federal Reserve will be vacated and ready for a new Trump

appointment--and perhaps the opportunity for an unexpected alteration of course.

     First among them, Trump nominee for chairman, Jay Powell, is seen as a

policy centrist who's expected to stick to the pace of gradual tightening set

out by Janet Yellen. As Fed governor, he never strayed far from the mainstream

of the official Federal Open Market Committee. 

     That is, as long as the economy keeps evolving broadly as expected. The

true test for the new leadership will be the unexpected: inflation rising well

above 2%, an economy headed for recession, or a shock from overseas.

     Trump and the GOP are rushing to deliver a tax overhaul that could spur

faster growth and an acceleration in inflation. With the unemployment rate

already at 4.1%, half a percentage point below the Fed's estimate of maximum

employment, current Fed officials are worried that wages and prices could rise

quicker than expected, necessitating a faster pace of interest rates increases.

     On the other hand, some market observers wonder if the markets could face

renewed turbulence as Fed rate hikes begin to bite and global central banks dial

back on liquidity provision. An unexpected economic shock could send rates back

to near-zero.

     How will the new Fed approach unconventional policy in the next recession? 

What role will it see for balance sheet policy? Will it be constrained by the

zero lower bound, or will it embrace negative rates already deployed in Europe?

     Although some Republicans pushed for President Donald Trump to nominate a

Fed critic to lead the organization, he chose Powell, a pragmatic moderate

aligned with the consensus view on the FOMC. But less is known about how Powell

might steer the committee in a different economic environment.

     Critics have said Powell lacks experience in a crisis. A lawyer by training

and a banker and investor by trade, he had no previous monetary policy

experience before coming to the Fed Board in 2012. He will be the first

non-economist to lead the institution in more than 30 years.

     But San Francisco Fed's Williams expressed few qualms about Powell's

qualifications. He told MNI in a recent interview that Powell an

intellectually-driven, action-oriented consensus builder in the mold of his

predecessors.

     He's also seen his share of ups and downs, Williams said. Difficulties in

the euro zone, the halting pace of economic recovery in the United States, the

Fed's rollout of QE3 and forward guidance and the balance sheet unwind have been

thorny challenges over the past six years, Williams said. "So he does have that

experience of being in the trenches."

     Trump has still other opportunities to put his stamp on the Fed.

     Assuming Yellen follows precedent and leaves her position as governor after

stepping down as chair, the president will need to name a vice chair and three

others to the Fed Board to join Powell, Randy Quarles and Lael Brainard.

     The powerful Federal Reserve Bank of New York is also searching for a new

president following Bill Dudley's announcement last week that he would retire by

mid-2018. Trump won't have a hand in picking his successor, who is selected by

the non-bank-affiliated directors of the bank's board, but the nomination is

subject to approval by the Fed Board in Washington.

     Dudley worked tirelessly alongside Yellen to support the economic recovery

and later to unwind the Fed's unconventional crisis-fighting tools. The New York

Fed president votes at every meeting and is responsible for implementing Fed

policy through open market operations. It's an important role that could help

reshape the Powell Fed.

     Among the other regional bank presidents, next year's FOMC voters skew more

hawkish. 

     Centrists Robert Kaplan and Patrick Harker and doves Charles Evans and Neel

Kashkari will be replaced by centrist John Williams, hawk Loretta Mester,

newcomer Raphael Bostic and the as-yet unannounced new chief of the Richmond

Fed. Jeffrey Lacker's successor in Richmond will likely favor higher rates as

the bank has traditionally supported hawkish monetary policy.

     Investors are expecting little change in monetary policy under a Powell

Fed. Should the economic winds of change blow, that assessment may prove less

enduring than they expect. 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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