Sleigh bells ring, are you listening? In the lane, snow is glistening. A beautiful sight (buffering... still buffering)...
Sorry to interrupt the connection to that gleeful, holiday song, yet there is an important public service announcement that needs to be made.
On January 1, the Federal Open Market Committee (FOMC) you knew in 2017 will cease to exist. The new year means there will be a new FOMC.
The change for the FOMC happens every year, yet that doesn't make it any less important, particularly since the voting members of the FOMC make the world go round in capital markets.
A Little Background
When the FOMC is at full capacity, there are twelve voting members: the seven members of the Board of Governors and five of the twelve Federal Reserve Bank presidents.
The president of the Federal Reserve Bank of New York has a permanent vote on the committee, so the remaining four presidents with a vote rotate annually. They serve one-year terms beginning January 1 each year.
Other Federal Reserve bank presidents attend the FOMC meetings and contribute to the discussions, but they do not cast a vote for setting policy.
The members of the Board of Governors are nominated by the President of the United States and confirmed by the Senate. There are three vacancies on the Board of Governors. There will soon be four, though, since Janet Yellen announced her resignation, effective when Jerome Powell is sworn in as Chair of the Board of Governors.
Currently, there are nine voting members on the FOMC, including Ms. Yellen.
Making a Move
President Trump has moved to fill one of the vacancies on the Board of Governors. In late November he nominated Marvin Goodfriend for Fed Governor.
Mr. Goodfriend is a Carnegie Mellon professor, a former director of research at the Richmond Fed, and a member of the Shadow Open Market Committee. He has endorsed rules-based decision making, has been critical of the Fed's quantitative easing practices, and isn't opposed to the use of negative interest rates as a policy tool.
Mr. Goodfriend is also committed to price stability, which some observers have interpreted to mean that he could easily play the part of dove or hawk depending on where inflation is relative to a fixed 2% target.
Mr. Goodfriend's approval to the Board of Governors is not assured, although most expect that he will win Senate approval. Until then, he will be on the outside looking in at the FOMC like the rest of us.
So, who do we know for sure will be calling the rate-hike shots in 2018?
Ms. Yellen will chair the January 30-31 FOMC meeting. After that meeting, however, she will be out, leaving only Jerome Powell (the Chairman), Randal Quarles, and Lael Brainard, none of whom dissented with the decision in December to raise the target range for the fed funds rate 25 basis points to 1.25% to 1.50%, in the FOMC governor seats.
New York Fed President Dudley will retain his voting power, yet he said this past November that he plans to retire in the middle of 2018.
His successor will be chosen by the New York Fed's board of directors. That choice will be watched closely given the important position of the New York Fed and the recognition that Mr. Dudley was a dovish ally of Ms. Yellen.
The four presidents who will rotate into a voting seat are Cleveland Fed President Loretta Mester, Richmond Fed President Thomas Barkin, Atlanta Fed President Raphael Bostic, and San Francisco Fed President John Williams.
Ms. Mester was a voting FOMC member in 2016 and dissented at the September and November meetings that year, preferring to raise rates. Mr. Williams was a voting FOMC member in 2015 and did not cast a dissenting vote at any of the meetings that year. Mr. Barkin and Mr. Bostic will be first-time voters on the FOMC.
Below is a brief glimpse of recent remarks pertaining to monetary policy views from each of these incoming members:
- In an interview with Bloomberg News on November 30, she said:
"There's a compelling case to keep this gradual increase in interest rates going... I'm not as worried about the inflation numbers, even though they are low relative to our goals."
"I just think long rates are going to go up given where we are in the economy and given where we see the economy going... But this is another reason why we need to keep raising up the short rate. These financial conditions are accommodative."
"It's [elevated stock market valuations] not a huge risk or an imminent problem, but something we need to be worried about... It's one of the risks I feed into why I think we need to be moving interest rates up."
- Mr. Barkin assumes his post as President of the Federal Reserve Bank of Richmond on January 1, 2018. There is no recent record of any monetary policy views held by Mr. Barkin who worked at McKinsey & Co. for 30 years, including stints as the consulting firm's chief risk officer at the time of his appointment and chief financial officer (2009-2015) prior to that. Mr. Barkin, who holds an MBA from Harvard, was a prior chairman of the Atlanta Fed's board of directors.
- In a September 26 speech to the Atlanta Press Club, he said:
"I conclude that monetary policy is not currently overly easy. But this is not a statement as to whether or not further adjustments in policy are required. My staff's own projections indicate continued strength in the economy and progress toward the FOMC's inflation objective as the year concludes and we move into 2018. I think clear evidence of this path could certainly be consistent with an additional rate hike this year. As for now, however, I have an open mind on when the next step in the normalization process will be necessary."
- In a December 18 interview with The Wall Street Journal, Mr Williams said:
"We are not in a rush to tighten monetary policy... We are kind of in a favorable situation... I don't see any really strong inflationary pressures pushing inflation up. I don't see any signs of other big risks to the economy, so I think we can move gradually." Mr.Williams added, "...something like three rate increases next year, and two to three increases in 2019—that seems like a reasonable view."
What It All Means
The rotation to a new FOMC comes at an interesting time. The U.S. economy -- and the global economy for that matter -- is picking up steam. Meanwhile, major stock indices are at record highs and asset valuations have been stretched on the persistence of low interest rates.
The question entering 2018 isn't whether the FOMC will raise the fed funds rate, but rather, how many times the FOMC will raise the fed funds rate in 2018.
The Federal Reserve's latest interest rate projections point to the potential for at least three rate hikes in 2018. The fed funds futures market, however, is only pricing in the probability of two rate hikes in 2018.
That's an important divergence, but unlike past years, there is a healthy respect for the possibility that the Federal Reserve -- and not the market -- will be right with its rate-hike projections.
The latter consideration stems in part from the fact that the Federal Reserve raised the fed funds rate three times in 2017, as it thought it might, and yet the economy and stock market strengthened right along with those rate hikes. Additionally, the passage of the tax bill is regarded by many as an expedient for stronger growth in 2018.
The incoming FOMC officials appear to be aligned with the gradual approach to raising the target range for the fed funds rate, but importantly, no one at this juncture is trying to sell the thought that the U.S. doesn't need another rate hike.
There is no clear-cut dove on the 2018 FOMC like there was on the 2017 FOMC with Minneapolis Fed President Kashkari, who voted against all three rate hikes. Rather, there seems to be a broad collection of centrists, which is fitting given the disparate economic dynamic of accelerating growth and low inflation that exists entering 2018.
A centrist by definition doesn't have strong conviction in their views. The 2018 FOMC, then, could do more, or less, than expected on the rate-hike front.
To this point, the stock market has greatly appreciated an FOMC that has been slow and deliberate with its rate hikes. There is a real market risk, then, if the 2018 FOMC ends up being more aggressive with its interest rate policy than is currently expected by the Federal Reserve itself.
Time will tell and Jerome Powell will soon be your narrator. In the meantime (buffering complete)... we're happy tonight, walking in a winter wonderland.