This week we focus on the US Federal Reserve (Fed). We explore looming changes in leadership and a pause in rate cuts that looks set to be maintained for some time given inflation and employment numbers.
With current chair, Jay Powell, stepping down in May, the drawn-out process for the nomination of a new Fed chair came to an end last Friday, with Kevin Warsh nominated by President Trump for the role. Approval of the nomination takes about 80 days, so we are moving into that period before Powell’s departure.
Warsh is a former Fed governor – he was at the central bank between 2006 and 2011, a period that spanned the global financial crisis. At the time he was seen as relatively hawkish because he voiced significant concerns that balance sheet expansion under quantitative easing would cause inflation. The market view now is that Warsh is one of the more credible candidates touted in recent months. Given that he was seen as being very uncomfortable with the thought of inflation during his Fed tenure, with inflation being a reality today it would be interesting to know what he is currently thinking.
In the first instance we need to bear in mind that the Fed is already very much in “wait and see” mode and there is little inclination to do anything with policy in the short term. Indeed, it seems likely that we have seen the last cut of Powell’s tenure. Although the past three meetings have resulted in 75 basis points of cuts, we are now firmly on hold.
Warsh’s view now is that inflation will be mitigated by increased productivity, so his concerns over inflation are diminished. Unlike some of the other Fed chair candidates, Warsh is not just seen as a rate cutter. Long-time front runner Kevin Hassett, for example, was seen as someone who would more likely bow to political pressure for additional cuts.
Friday’s market reception to the news was a little bit uncomfortable. Gold and silver both made dramatic downward moves – albeit from very overbought positions. Price charts for both had gone parabolic in preceding weeks so it was no surprise to see a pullback. In terms of the rate outlook, expectations for a cut rose marginally, with the next reduction expected in June and a further cut before the end of the year. It is worth remembering, however, that a lot is set to happen in the meantime in terms of the nomination process and US economic data. For now, the way the US economy is ticking along really doesn’t justify the Fed cutting rates. Perceptions of the pathway for rates may change if we see a deterioration in employment numbers, and while this has softened it is not worsening dramatically. More likely is an acceleration within the US economy given the amount of fiscal stimulus in play.
So, while markets are still pricing further rate cuts, a lot can change. It is also worth being cognisant of other issues: there are efforts to fire Fed governor Lisa Cook, as well as an ongoing Department of Justice investigation into the refurbishment of the Fed headquarters.
In summary, markets should be comfortable with what looks like a credible appointment. And while we will likely see further pressure on the Fed from Trump to cut rates, I think Warsh and other board members will do their best to preserve the bank’s independence.
By Anthony Willis, Senior Economist at Columbia Threadneedle Investments.
Watch the latest video here:Did the Federal Reserve just turn more hawkish or dovish?
