Business as usual at the Fed under 'safe' Powell

President Trump has nominated Fed Governor Jerome Powell to be the next chair of the Federal Reserve. Powell will replace Janet Yellen, from whom he inherits an economy marked by low unemployment, low inflation and steady, if uninspiring, growth. 

He will take the reins of the central bank at a pivotal time, as the Fed navigates the ongoing normalisation of monetary policy after nearly a decade of extraordinary accommodation, along with the unwind of its massive $4 trillion-plus balance sheet. His nomination is subject to confirmation by the Senate. 

Powell is widely considered to be the 'safe' choice for the role. A member of the Fed’s board of governors since 2012, he has been a consistent supporter of Yellen’s patient approach to policy normalisation and his nomination raises expectations of continuity with the slow-and-steady path charted by the Yellen Fed. 

Yellen, whose term as Fed chair ends in February 2018, was an effective steward of the central bank during her four years at the helm. Under her watch, unemployment fell from 6.6 per cent to 4.2 per cent, at or near what many economists consider to be full employment, though inflation has consistently fallen short of the central bank’s 2 per cent target. 

Trump’s decision to replace Yellen represents a break from recent tradition. Going back to President Reagan, new presidents have nominated the sitting FOMC chair for another term irrespective of party affiliations.

The most conventional choice 

While replacing a Fed chair represents a new – and self-inflicted – risk to the economy, Powell was the most conventional choice among those non-Yellen candidates the president was purportedly considering for the job. Powell has been a consistent ally of Yellen since his appointment to the Fed board in 2012, though he is seen as less hawkish on regulatory matters than his predecessor. 

Prior to joining the FOMC, Powell spent his professional career in a combination of public and private jobs. Notably, he was a Treasury Department official during the George HW Bush administration and an investment banker with private equity firm Carlyle Group. 

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Though the pool of candidates for the Fed post had been winnowed down to a five-person short list – one that included Yellen – reports in recent days suggested a two-way race between Powell and Stanford economist John Taylor.

In contrast with the consistency that Powell’s nomination represents, Taylor has been an outspoken critic of Fed policy for many years, long contending monetary conditions have been exceedingly accommodating. 

Taylor appeared to be the preferred candidate of many conservatives, including Vice President Pence. While this suggests that Powell may face some aggressive questioning in the Senate, he is expected to achieve the simple majority needed for confirmation. 

Expect more of the same   

What can we expect from a Powell-led Fed? More of the same, likely. Despite the change in leadership, we anticipate the Fed will continue to gradually hike the Fed’s benchmark rate, as conditions warrant, while at the same time seeking to unwind the central bank’s bloated balance sheet in a manner that spares the financial markets from turmoil. 

Futures markets overwhelmingly expect the Fed to raise the federal funds rate by 25bp following its 13 December policy meeting. The central bank’s latest 'dot-plot' of interest rate projections implies three additional 25bp hikes in 2018, bringing its policy rate up above 2 per cent by year-end. In October, the Fed began to trim the size of its bond portfolio, by allowing $6 billion of treasuries and $4 billion of mortgage-backed securities to mature every month without reinvestment. 

While policy continuity is welcomed, we could see market volatility re-emerge as central bank normalisation evolves. Not only has the Fed recently embarked on balance-sheet reduction, but the European Central Bank announced plans to reduce the size of its monthly asset purchases and also extend the duration of its QE program, while the Bank of England raised its benchmark rate for the first time in a decade yesterday. 

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Ashok Bhatia is senior portfolio manager at Neuberger Berman. 

Keep up to date with all the latest financial news and investment tips by signing up to our newsletter. Email subscribers will also receive a free print copy of Money Observer magazine.   


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