I have a theory.
Great Fed Rotation
All this is happening as the Fed is on the cusp of drastic change.
The Federal Reserve System has a seven-member Board of Governors. Three of those seven seats are currently vacant. President Trump has not nominated anyone yet, although two names have been floated in the press (including NIRP lover Goodfriend). Even if Trump were to nominate them tomorrow, they would still have to go through Senate confirmation, and the Senators have a lot on their plates.
Meanwhile, Janet Yellen’s term in the chair expires on February 8, 2018, and Vice-Chair Stanley Fischer’s term ends in June 2018. Their board terms are separate, so both could theoretically remain governors after their leadership terms expire, but most observers expect them to retire. Their staying would not be without precedent (I think there was one exception), but it certainly would be an eye-opener. So, if things go as expected, Trump will have two more seats to fill.
So, we are potentially one year away from a Board of Governors with at least five of the seven being Trump appointees. And it seems highly likely that Lael Brainard will not stick around much longer after Yellen leaves, and then the only question remaining is whether Jerome Powell steps down. I know nothing of his plans, but it could happen. Is his ideal career move to remain on the FOMC as the odd man out?
The seven Fed governors – when there are that many – all sit on the Federal Open Market Committee, which sets interest rates and makes other monetary policy. Also voting on the FOMC are the New York Fed’s president and a rotating cast of four other regional Fed presidents.
President Trump does not appoint the regional Fed bank presidents. They answer to their own boards, which comprise bankers from their regions. So the FOMC has both political appointees and commercial bank representatives. It was set up that way on purpose. But it’s also no accident that the political appointees constitute a majority – or will when more Trump appointees take their seats.
The FOMC works by consensus. Most of its decisions are unanimous or almost unanimous. Fed chairs strive mightily to get everyone on the same page, which I’m sure is tough, on the level of herding cats or getting Republicans in the House to agree. It’s also important – banks and private businesses want to see stability.
Enter Donald Trump, for whom stability is a lesser priority.
The FOMC members must see what is coming. Their beloved unity is in danger, and I doubt they are pleased. I believe a faction on the FOMC wants to cement its own preferred policies in place and make it difficult or impossible for a new majority to change course in 2018 or thereafter. Yellen, Fischer, and Dudley all seem to be of that mind, and they are now taking a hawkish approach to monetary policy. That’s why they don’t want to do the otherwise sensible thing, which is to wait for more evidence that inflation is a problem before tightening further, especially so late in the recovery cycle.