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The Powell Fed: Continuity in Monetary Policy

We believe Jerome Powell is a smart choice for Fed chair.

President Trump has announced Fed Governor Jerome Powell as his nominee for Chair of the Federal Reserve Board. A Fed governor since 2012, Powell has been confirmed twice by the U.S. Senate and likely will be confirmed as chair without controversy in time to take over when current Chair Janet Yellen’s term expires in February 2018. “Jay” Powell, a lawyer by training, served in the 1990s as a senior official in the U.S. Treasury and, before joining the Fed, was an executive with the Carlyle Group.

Onward with Fed policy normalization

Powell, who has never dissented in a monetary policy vote during his service as governor, is expected to maintain the framework for policy normalization put in place by the Yellen Fed. For 2018, the Fed guidance currently in place calls for rates to continue to rise gradually, with the median Fed projection  that three hikes will be appropriate next year if the economy performs as forecast.

We expect likewise for the Fed’s current plans for shrinking its balance sheet, a process which commenced in October. This plan – which Powell helped develop – has been well-communicated to markets and has so far not triggered a replay of the 2013 taper tantrum. It calls for a predictable reduction each month in the Fed’s holdings of Treasuries and mortgage securities.

On financial regulation, Powell has acknowledged that a case can be made for modifying the Volcker rule and for making it easier for smaller banks to comply with the Fed’s annual stress test exercise.

Longer-term questions on fed funds rate, balance sheet

In 2019 and beyond, a Powell Fed must make crucial decisions – left unresolved by the Yellen Fed – on when and how to end the process of policy normalization. Specifically, at some point the Fed will have to decide when to stop hiking interest rates and when to stop shrinking the balance sheet. In his public statements, Powell appears to embrace PIMCO’s New Neutral concept that the destination for the federal funds rate during this rate hike cycle will be a much lower level than was the case before the global financial crisis. However, Fed officials don’t agree on what this New Neutral level is, and Powell will need to forge a consensus somehow.

It’s a similar story for the Fed’s balance sheet normalization. Today all Fed officials agree that the balance sheet should be smaller, but there’s no agreement on the optimal ultimate size. At some point, as Fed chair, Powell will have to build consensus for this policy decision as well.

Looking forward

We believe Jerome Powell is a smart choice for Fed chair. He is likely to provide continuity in the monetary policy framework developed by the Yellen Fed for a gradual normalization of the policy rate and a predictable reduction in the Fed’s balance sheet, though in the longer term the Powell Fed will have some critical decisions to make about the ultimate destination for both the rate and the balance sheet. Also, we note that Powell is probably more receptive to concerns that the pendulum in financial regulation has swung too far, and therefore more open to suggestions for prudent adjustments, especially for smaller banks.

We are optimistic about the Fed’s next chair and next chapter.

The Author

Richard Clarida

Former Global Strategic Advisor, 2006-2018

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