Originally posted at Briefing.com
Out with the old and in with the new. It happens every year with the Federal Open Market Committee (FOMC) and the regional bank presidents who have a vote on that committee. The turnover occurs January 1, and it's important to know who the new voters will be since their policy views will go a long way toward shaping the outlook for the global economy and the capital markets.
A Little Background
When it is at full capacity, there are twelve voting members on the FOMC: the seven members of the Board of Governors and five of the twelve Federal Reserve Bank presidents.
The president of the Federal Reserve Bank of New York has a permanent vote on the committee, so the remaining four presidents with a vote rotate annually. They serve one-year terms beginning on January 1 each year. Other Federal Reserve bank presidents attend the FOMC meetings and contribute to the discussions, but they do not cast a vote for setting policy.
The members of the Board of Governors are nominated by the President of the United States and are confirmed by the Senate. There are currently two vacancies on the Board of Governors. Consequently, there are only ten voting members on the FOMC at the moment.
As an aside, President Obama nominated Allan Landon and Kathryn Dominguez to fill the two vacancies on the Board of Governors, yet neither had a confirmation hearing. Neither will be having a confirmation hearing either considering there will be a Republican president in 2017 who will be making his own nominations for those open seats. Those confirmation hearings are certain to be held, too, by the GOP-controlled Senate, so the Federal Open Market Committee will be operating again at full strength in due time.
The 2016 FOMC voters are: Janet Yellen (Board of Governors, Chair), Stanley Fischer (Board of Governors, Vice Chair), Lael Brainard (Board of Governors), Jerome H. Powell (Board of Governors), Daniel Tarullo (Board of Governors), New York Fed President William Dudley, St. Louis Fed President James Bullard, Kansas City Fed President Esther George, Cleveland Fed President Loretta Mester, and Boston Fed President Eric Rosengren.
The 2016 FOMC has been a divisive group for the capital markets given its flawed communication efforts. Moreover, individual members shared disparate views that left market participants feeling confused about when the FOMC would ultimately raise the target range for the federal funds rate again after it was raised for the first time since June 2006 in December 2015.
Remarkably, we said the very same thing about the communication shortcomings of the 2015 FOMC in our preview of the 2016 FOMC. Hopefully, we won't have to say the same thing about the 2017 FOMC in our preview of the 2018 FOMC.
One other glaring similarity is that the 2016 FOMC looks increasingly likely to go out the same way the 2015 FOMC did: raising the target range for the fed funds rate by 25 basis points at its December meeting, which would mark the only rate hike of the year.
That expectation is cemented in the fed funds futures market, which is currently pricing in a 94.9% probability of a rate hike at the December meeting.
So, who will be calling the rate-hike shots in 2017?
The five Fed governors will remain the same, assuming none step down. That group—Yellen, Fischer, Brainard, Powell, and Tarullo—has been a dovish-leaning contingent. They've paid ample lip service to the possibility of raising rates, but when push came to shove at some opportune times in 2015, they pretty much opted to keep pushing on the string and left the fed funds rate unchanged.
Their preference was not always shared by all FOMC members. Kansas City Fed President George dissented at five of the seven meetings, preferring instead to raise the fed funds rate by 25 basis points. She was alone in her dissent until the September FOMC meeting when she was joined by Cleveland Fed President Mester and Boston Fed President Rosengren.
Mr. Rosengren backed away from his rate-hike preference at the November meeting, yet Ms. George and Ms. Mester held true to their hawkish form.
In less than a month's time, however, their hawkish bias will be an afterthought. Granted they're likely to still share some interesting policy perspective, yet the markets pretty much only care about the positions of the Fed presidents who actually have a vote on the FOMC.
With that, the four new presidents who will rotate into a voting seat are Chicago Fed President Charles Evans, Dallas Fed President Robert Kaplan, Minneapolis Fed President Neel Kashkari, and Philadelphia Fed President Patrick Harker.
Mr. Evans, who is widely regarded as the most dovish Fed president, has been a voting member of the FOMC before. Mr. Kaplan, Mr. Kashkari, and Mr. Harker will all be first timers.
Below is a brief glimpse of recent remarks on monetary policy from each of these incoming members:
- In an October 24 speech on monetary policy in a lower interest rate environment, Mr. Evans said lower potential output growth means the current policy is not as accommodative and that means there is less headroom to increase rates. It also means appropriate monetary policy might require undershooting the unemployment rate [and] overshooting the inflation target.
- In a November 30 speech on economic conditions, key secular trends, and the limits of monetary policy, Mr. Kaplan said, "In light of the challenges posed by the broad secular drivers I discussed earlier, I have been suggesting that removal of accommodation should be done gradually and patiently. I am cognizant that, from a risk-management point of view, our monetary policy tools are asymmetrical at or near the zero lower bound—that is, it is easier to tighten policy than to ease policy at this point in the normalization process.
Lastly, I have repeatedly stated that I believe it is important that we strive to take steps to "normalize" monetary policy because there is a cost to excessive accommodation in terms of penalizing savers, as well as creating potential distortions and imbalances in asset allocation, investing, hiring and other business decisions. These imbalances are often easier to recognize in hindsight and can be very painful to address. Based on these considerations, as we continue to make progress in achieving our dual mandate, I would advocate that we take action to remove some amounts of accommodation... Monetary policy is a key element of economic policy—but it shouldn't be the only element of policy. To improve future economic outcomes for our citizens, we need to consider structural and fiscal policies alongside sound monetary policy."
- In a May 9 speech on the role and limitations of monetary policy, Mr. Kashkari said, "In short, given the lack of notable price and wage pressures and the possibility of drawing more people back into the labor market, I believe the current accommodative policy stance is appropriate. The usual cost of stimulating the labor market through accommodative monetary policy would be an undesired increase in inflation. But in the current circumstances, with inflation running below the Fed's 2 percent target, an increase in inflation is actually desirable. Furthermore, while monetary policy's influence on the labor market may not be enormous at this point, we can have at least some impact. If we can continue bringing displaced workers back into the labor force, we should.
Fed watchers might conclude from these remarks that I am a so-called dove. But a year or two from now, if different economic conditions lead me to call for less accommodative policy, they might conclude that I have reversed myself and become a hawk. The truth is neither. The financial crisis taught me the limits of dogma. I learned humility and pragmatism the hard way... I look forward to an era when the United States uses all of its policy tools to best achieve good economic outcomes for all members of our society. The Federal Reserve has a role to play, but we shouldn't be the only player nor the most important one."
- In an October 13 interview with The Wall Street Journal, Mr. Harker said, "I think, as we move toward normalization and if we believe the risks are balanced, which I do, then—and there are some risks that I'm worried about, such as some distortive effects of a low interest rate environment—then it's time to move, and then see what happens, and then move.
So you're right, you'll never perfectly know what's going to happen, say, 18 months from now after you make that move, but you can get some glimpse of it with how markets respond and expectations become anchored or unanchored relative to such a move... as we discussed earlier, with the lags that we know are in such a dynamic stochastic system, I think it's important that we take some move now and have a gradual path of normalization, as opposed to wait, wait, wait, and then have to have a steeper rise. I just think that's prudent."
What It All Means
The rotation to a new FOMC comes at an interesting time. The economic data at home has been improving, evidenced by the 3.2% real GDP growth rate for the third quarter. Meanwhile, the incoming Trump Administration is aiming to introduce legislation on tax reform, deregulation, and infrastructure spending in President Trump's first 100 days in office.
Many market participants are expecting those initiatives to lead to stronger economic growth in 2017, which would presumably be accompanied by higher inflation.
Accordingly, the market has been working to get its mind around the possibility that the FOMC could be more active in raising the fed funds rate in 2017 than it has been certainly over the last seven years. To be sure, it wouldn't take much for that to be the case. Two rate hikes in a single year would qualify.
Time and data will tell, yet the views expressed by the incoming FOMC presidents to this point make it sound like they are open to a rate hike soon but think the pace of policy rate normalization should be gradual.
We don't think this paints them definitively as hawks or doves. Rather, we're inclined to label the entire 2017 FOMC as centrist. They will be data watchers through and through, with a policy mindset that we're inclined at this juncture to think will be more reactive than proactive.
That has the potential to create some problems for the capital markets if they think the FOMC is late with its policy actions.
The year ahead is going to be like all new years: laced with blanks of uncertainty that get filled in as the year progresses. What goes in those blanks is obviously the great unknown at this juncture, but one thing known for sure is that the 2017 FOMC is going to factor prominently in the year ahead as a blank filler and a market mover.