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Analysis
Clash over Fed policy escalates

Clash over Fed policy escalates

Powell must be ready for consequences of transparency

by Darrell Delamaide in Washington

Thu 4 Apr 2019

The reversal of US monetary policy by Federal Reserve Chair Jay Powell and his troops to be super-accommodative has done little to quell the pressure on policy-makers. In fact, it seems to have escalated the war on Fed policy; investors and President Donald Trump are pushing for a rate cut when the Federal Open Market Committee has only recently abandoned its path of gradual rate rises.

Stephen Moore, an economic adviser to Trump during his 2016 campaign, wrote a blistering op-ed in mid-March attacking Powell and the Fed as a threat to growth. A week later, Trump said he will nominate Moore to one of the two vacancies on the Fed's board of governors, and the former television commentator called for an immediate rate cut.

In an interview with the New York Times, Moore said he regretted his earlier criticism of Powell and the harsh language he used in the op-ed. 'I was really angry,' Moore said, blaming the Fed's decision to proceed with a planned rate rise in December even though there were abundant signs of slowing growth and inflation was in abeyance.

'I was furious – and Trump was furious, too,' Moore said. 'I just thought that the December rate increase was inexplicable. Commodity prices were already falling dramatically.' Trump's chief economic adviser, Larry Kudlow, echoed Moore's call for an immediate rate cut, saying that reflects the president's thinking.

Moore's nomination is bound to encounter stiff resistance in the Senate, where Democrats consider him a lackey for the president and a threat to central bank independence.

In the interview, Moore said both the September and December increases of a quarter point were mistakes and that the Fed should reverse them, lowering the benchmark Fed funds rate from its current 2.25%-2.5% range by a half-percentage point. Investors are on board with that view. Fed funds futures are predicting a rate a quarter to a half-point lower in December by nearly a two-thirds margin.

However, it flies in the face of what appears to be a consensus among policy-makers. Even the yield curve inversion in late March, when the yield on three-month Treasuries topped that of 10-year notes, is not enough to motivate FOMC members to cut rates.

'We're not there yet,' Dallas Fed Chief Robert Kaplan told the Wall Street Journal. 'I'd need to see an inversion of some magnitude and/or some duration, and right now we don't have either.'

The inversion sparked a stock market selloff because such a move is supposed to signal a recession. However, former Fed Chair Janet Yellen said after the Fed's asset-purchase program has flattened the yield curve, such an inversion might just be suggesting the need for a rate cut.

For the most part, Fed policy-makers are following Powell's lead in calling for patience, holding off on any further rate moves, even as they insist the economy is still in good shape.

Speaking at a conference in Hong Kong, Chicago Fed President Charles Evans said the FOMC could go either direction, depending on economic performance. If the economy goes as he expects, the Fed could raise rates again, though this would probably not be before the second half of next year. He acknowledged that downside risks loom larger than positive risks.

James Bullard, head of the St. Louis Fed, said he remains optimistic about the economy and thinks the Fed should see how things develop. 'I wouldn't lean toward moving in either the upward or downward direction with respect to rates in 2019,' he said. He added that a sustained yield curve inversion would worry him, but it would have to be longer than a few days.

Bullard has argued for some time that the economy does not need rate increases. Likewise, Minneapolis Fed Chief Neel Kashkari has diverged from the consensus in his focus on labour market participation.

'If people are choosing to work,' Kashkari tweeted in late March, 'why should that be unsustainable? Why don't they represent a greater supply potential than we realised rather than some unsustainable overheating?'

Powell tried unsuccessfully at his press conference following the March FOMC meeting to balance cheerleading for the economy while announcing several accommodative measures. These included, notably, a halt to the Fed's balance sheet runoff, leaving it at $3.5tn, nearly four times what it had been prior to the 2008 financial crisis.

'The US economy is in a good place, and we will continue to use our monetary policy tools to help keep it there,' Powell said, even as his actions belied his words. The dissonance spooked investors, sending stock prices down. The inversion of the yield curve in the following week scared them again.

Asked whether futures markets were right in predicting a rate cut, Powell could only say the Fed was waiting for a signal whether rates need to go up or down. 'It's a great time for us to be patient and watch and wait and see how things evolve,' he said, falling back on his mantra.

Investors aren't buying it and Powell's communications problems continue. It may be a phase that simply doesn't favour communication. In any case, Fed policy-makers must accept the consequences of their transparency. With critics like Moore poised to join the board, that will not get any easier.

Darrell Delamaide is US Editor of OMFIF.

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