Yellen Years at the Fed (Feb. 7)

Update 248:  Yellen Years at the Fed

All’s Well and it Ends with Wells

With markets calmer now following a correction that gave back all of this January’s paper gains in three early-February trading sessions, we can take a longer-term look at a key transition in Washington crowded out by correction coverage.

Janet Yellen concluded her term as Federal Reserve Board Chair last week.  During her four years in charge, the unemployment rate shrunk from 6.7 percent to 4.1 percent and the economy has sustained one of the longest-running recoveries and consecutive months of growth in the nation’s history.  A retrospective on the Yellen years and what lies ahead at the Fed follows.







The Yellen Consensus


The Yellen consensus is her careful consensus building approach that led to many unanimous decisions. During her tenure, Yellen averaged 0.71 dissents per meeting. For reference, former chair Volcker averaged around 1.23 dissents per meeting. Powell takes over that consensus building approach and is not looking to bring about earth shattering change in either regulatory or monetary policy arenas.

   Source: Thornton and Wheelock (2014)

The intricate and high-stakes business of interpreting economic data and deciding collectively on monetary policy is a critical consensus building task at which Yellen excelled. Studying at the elbow of her predecessor Ben Bernanke, she maintained the consensus and policy course he designed to help with economic recovery from crisis.


As a result, Yellen was able to set the Board on a remarkably smooth path to normalization, beginning with a complex and historically unprecedented two-fold process:

  • Interest Rates: Gradually increase the near-zero federal funds rate
  • Balance Sheet:  Begin reducing the Fed’s $4.5 trillion balance sheet holdings

Interest Rates

In 2014, Janet Yellen inherited a federal funds rate that had been under 0.25 percent since 2009. In late 2015, the Fed increased the federal funds rate to a range between 0.25 percent and 0.50 percent. Since early 2017, the federal funds rate was increased four times, and today it ranges between 1.25 and 1.50 percent.  The Fed under Chair Powell will have to determine whether to execute the plan to increase rates three times in 2018 and aim to finish the year with a federal funds rate at 2.00-2.25 percent. Many view three percent as the “normal” federal funds rate.

Balance Sheet Normalization

In 2014, Yellen inherited a sizeable $4.5 trillion Federal Reserve balance sheet. Over the previous six years, the Fed bought bonds to depress long-term borrowing rates. Last October, Yellen initiated a process to sell off the Fed’s holdings. Chair Powell expects the balance sheet to shrink to a total ranging from $2.4 to $2.9 trillion by 2022.


The Road from Here


  •  Fiscal/Monetary Policy Crosscurrents


One of the first challenges that the post-Yellen Fed will have to contend with is the massive, deficit-financed fiscal expenditures emanating from the Trump administration and the Republican-controlled Congress. As a body that is focused on monetary policy, the Fed won’t have a say in the fiscal stimulus envisioned by the White House and enacted by Congress, but it will certainly have to deal with the consequences.


The Tax Cuts and Jobs Act will add at least $1.5 trillion in new debt over the next decade, and the President has suggested hundreds of billions more, at least. Adding trillions in additional debt to the economy will have consequences that Powell and his fellow Governors will have to monitor closely.


While concerns about rampant inflation are misplaced, (the Fed has been primarily concerned with deflationary pressures for almost a decade), new deficits certainly run the risk of driving interest rates up more quickly than Powell would prefer. Economists estimate that a one percent increase in the deficit-to-GDP ratio translates to a roughly 25 basis point increase in long term interest rates. This could lead to a collision between DC and bond markets in New York and Chicago.


As we’ve seen over the past couple of days, markets are increasingly nervous about how the Fed might react to fiscal stimulus. All this will surely influence the Fed’s decision making about interest rate normalization and might well alter the schedule of rate increases. If all of a sudden there is no such thing as a bad deficit, the Fed — and the markets — will surely take notice.


  •   Regulatory/Supervisory Policy


The Fed is commonly described as having a “dual mandate” relating to employment and inflation. However, the Fed has another task: regulating banks. While the new chairman will carefully consider the scheduled interest rate hikes mentioned above, the Fed has a few other regulatory levers at its disposal that many, especially in the administration, would like to see tinkered with.


A key player in the conversation of regulatory oversight at the Fed is recently appointed vice-chair Randal Quarles. Where Powell voted in favor of every major post-crisis regulation and is seen as being cut from the same cloth as Yellen, Quarles is a far more conservative, small-government, regulator. He will be pushing an agenda of deregulating Wall Street starting with some of the protections put in place under the Dodd Frank Act that are up for negotiation.


Quarles’ deregulatory instincts mesh perfectly with a troubling bill working its way through the Senate now, S.2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act. The bill takes aim at four pillars of Dodd Frank: the SIFI threshold, stress testing, living wills, and the Liquidity Coverage Ratio (LCR). The Fed is currently considering reducing the LCR, which compels large banks to keep a certain level of highly liquid assets on hand to protect against any large market shocks. This, along with the constant pressure to de-list SIFI’s and defang the Volcker Rule, will be the most important threats to Obama-era systemic risk protections from the Fed.


  •  Yellen’s Last Act


Janet Yellen’s final act as Chair of the Federal Reserve was to dole out unprecedented enforcement actions to Wells Fargo & Co. on Friday. The Fed voted 3-0 that Wells Fargo would replace four board members in 2018, along with an enforcement action targeted at limiting the growth of the nation’s third largest bank. In taking these actions, the Fed signaled to big banks that when they fail to manage risk, both managers and boards will be held accountable.


The enforcement action taken bars Wells Fargo from growing beyond $1.95 trillion in assets — it’s reported size at the end of 2017 — unless given permission from regulators. “The Fed just put the fear of God into bank boardrooms across the country,” Ian Katz, an analyst at Capital Alpha Partners, wrote in a note on Sunday. “And that’s exactly what it wants to do.”


Yellen has been discussing taking enforcement action against Wells Fargo, whose massive fake account scandal hurt consumers and enraged progressives in Congress.  The unanimous vote closed out the Yellen era with a bang.


Future of the Yellen Consensus


This action is likely to renew Congressional interest in the Wells Fargo matter, especially if Democrats win the House and Ranking Member Waters (D-CA) takes the House Financial Services Committee gavel. The action was one of the most unprecedented moves in the Fed’s history, and watch for Powell – who sees eye to eye with Yellen on so many issues – to uphold this action.


Yellen leaves the Fed in close consensus on rates, normalization, Dodd-Frank, and other regulatory issues.  The Yellen years were years of stable recovery that served the country well.  We owe Yellen and the Board a debt of gratitude, and we wish Chair Powell the best — by which we mean, “more of the same please.”

Update 219: Who is Jay Powell?

Trump’s Expected Fed Chair Pick Seen Likely More Establishment than Bannonist (Oct. 30)

Update 217: Trump’s Expected Fed Chair Pick Seen Likely More Establishment than Bannonist

This Thursday, President Trump is expected to nominate the next Federal Reserve Chair.  After months of speculation, the prohibitive favorite at this hour is current Fed Governor Jay Powell.  But Trump enjoys the elements of suspense and surprise and has thrust the nomination into the public forum, even conducting an informal poll of Senate Republicans at a conference lunch.

Will he decide at the last minute to nominate hawks Warsh or Taylor… or will he stay the course with Yellen?   Below we examine the key policy implications of each potential Fed Chair and the considerations that may bear on the candidate’s Senate confirmation vote.




Implications for Monetary Policy

•  Interest Rate Policy

Powell:  Powell presents a “centrist” approach to monetary policy.  As a Fed governor, he often voted with the board to maintain a near-zero interest rate environment in order to aid recovery efforts.  A close colleague of the current Chair, Janet Yellen, Powell would maintain the current policy course of gradual rate hikes to sustain steady economic expansion and falling unemployment.

Warsh:  Warsh’s limited experience as a Fed Governor from 2006 to 2011 provides little certainly regarding in his monetary policy expertise.  While serving on the board, Warsh wildly overestimated the risk of inflation, which teetered at a mere two percent at the time. As Fed Chair, he is expected to aim for higher interest rates than what is presently expected from current Fed policies.

Taylor:  Taylor’s candidacy incites fear in investors. His blatant promotion of the eponymous Taylor Rule, which dictates where the federal funds rate should be considering prevailing conditions, would increase the current rate to slightly over three percent. Economists and market analysts alike are skeptical about whether the economy is ready for such a change in direction.

Yellen:  Yellen’s experience and consistency in monetary policy has produced undeniable economic success.  She is expected to continue present policies if reappointed.  Her strategy would follow the course of gradual, inflation-dependent interest rate increases.

•  Pursuit of the Neutral Rate

The neutral rate is the rate at which the GDP grows at the optimal rate while maintaining stable inflation. The Fed recently reduced its expectation of the neutral rate from 3 percent to 2.75 percent. This is a historical low for the estimate, but given the slow recovery of the economy, the figure is reasonable.

Each candidate has a specific view of what the neutral rate should be. Candidates like Yellen and Powell are in sync on holding the neutral interest rate at 2.75 percent before inflation. Taylor and Warsh stand on the opposite side of the debate. Warsh claims this rate should be higher than the Fed’s projection and Taylor’s Rule would put this rate at 3.13 percent before inflation.

Implications for Fed Asset Selling Program

Reducing the Treasury’s balance sheet is one of the largest items on the agenda for the next Fed Chair. Most of the candidates would accelerate the normalization process.  By selling off Treasury holdings, the Fed would inject securities into the economy and steadily push the interest rate upwards.

Yellen is committed to a slow and steady normalization regimen. Powell, who voted in support of quantitative easing a few years ago, supports a faster rate of normalization than Chair Yellen. Taylor and Warsh would accelerate the normalization process. Taylor’s belief in a less-interventionist Fed suggests he will pursue relatively rapid normalization efforts. Warsh holds a similar view. He disagreed substantially with the Fed’s second round of bond-buying in 2011.

Implications for Regulatory Policy

The Dodd Frank Act has been under attack since the Administration took over, but at the Fed, Yellen has been stalwart in maintaining the authority and practices implemented since the crash.  Each candidate in contention to replace her may soften these protections to varying degrees.

Powell, the odds-on favorite, would be the next best protector of Dodd Frank.  However, he believes some DFA provisions are unnecessarily burdensome and are inappropriately applied to small and medium sized banks.

Taylor comes next in terms of deregulatory tendencies.  Though Taylor is more vocal and better-known for his monetary policy preferences regarding the interest rate, he has made it clear he believes firms are micromanaged post-crisis and would take steps to loosen the protections Dodd Frank put in place for banks of all sizes.

Warsh is the true embodiment of the deregulatory impulse. During the financial crisis, he was a strident critic of Chairs Bernanke and Yellen’s balance sheet policies.  He has maintained his pre-crisis stance on deregulating Wall Street. Democrats would vehemently oppose a Warsh nomination to preserve the Dodd Frank Act’s progress.

Political Factors and Senate Confirmation

After the President makes his announcement, the candidate will go before a Senate eager to weigh in.

Powell:  Powell received two separate confirmations for a seat on the Board of Governors in 2012 and 2014. In 2014, he was confirmed with no Democratic Nay’s and ten Yea’s from Republicans still in the Senate. Powell’s centrism raises concerns among some Republican Senators. Senator Scott said that Powell would have to “answer serious concerns both old and new at any potential nomination hearing”. His previous confirmation will muddy the waters for both Democrats and Republicans looking to change their votes, and the confirmation hearings will certainly be intense if he is nominated.

Warsh:  In 2006 Warsh was confirmed to be a Federal Reserve Board Governor by a voice vote. At 35, there was significant concern that he was too young and inexperienced for the role. 11 years later he would still be a toxic pick in the eyes of Senate Democrats and potentially more than a few Republicans. He has no academic background in economics, missed the mark with many of his predictions during the ‘08 crisis, and appears to be an active Republican fundraiser. He would be both a dangerous pick and difficult confirmation.

Taylor:  Taylor was confirmed by the Senate in 2001 to be Treasury undersecretary in the Bush administration.  He passed via voice vote and is seen as a politically vanilla academic.  While his policies provide cause for concern for Democrats as mentioned above, he would likely receive the needed majority from the right. Choosing Taylor would be a win for those who wish to constrain the Fed’s intervention, despite the likelihood Taylor would raise rates.

Yellen:  Janet Yellen was confirmed by the Senate in 2014 with 56 Yea’s and 26 Nay’s.  All Nay’s were Republican, 23 of whom still serve.  Yellen received broad Democratic support and four Yea’s from Republicans who still serve. She is the near consensus choice for academic and Wall Street economists and Yellen would be the most palatable option for Democrats. This latter point would make her renomination a difficult pill to swallow for Senate Republicans — not only do many of them disagree with her on policy grounds but four more years of a Yellen-led Fed would be perceived as a Democratic win.

On Monetary Policy, Much Ado (Sep. 20)

Musical Fed Board Chairs Post-Wyoming (Aug. 29)

Update 198 –- Musical Fed Board Chairs Post-Wyoming, All Over But the Yellen?

Fed Chair Janet Yellen delivered remarks on the state of financial stability on Friday in Jackson Hole, Wyoming at the Fed’s renown annual economic policy symposium.  Ten years after the onset of the Great Recession, the Chair took the opportunity to reflect on the impact of the Dodd-Frank Act (DFA) on the recovery of the financial system and economic growth since its enactment.

The speech comes as Janet Yellen enters the last six months of her turn at the helm of the Fed.  It makes clear that her re-appointment would be a vote for DFA, for systemic stability, and for continuity in the Fed’s program of monetary policy normalization.

This doesn’t sound one bit Trumpian, does it?  What is Trump’s alternative as Chair, a rate-raising inflation-phobic bond vigilante?  A free marketeer?  Where would current front runner for the post, NEC Director Gary Cohn fit in?  Let’s see.




The Wall Street Journal’s lead editorial today criticizes Chair Yellen’s Wyoming speech and the regulatory community for its advocacy of DFA.  The Journal appears to be mistaking for political activism the regulatory responsibility to implement the law.  Dodd-Frank and the rules it mandated that regulators implement was passed by an act of Congress and signed into law by the president of the United States — all of them elected officials.

In a three-part speech outlining the history of the great recession, the increased safety of the system, and the remaining challenges we face, Yellen articulated the successes of DFA.  In so doing, Yellen indicates no concern about the impact of her views on President Trump’s nomination of the next Fed Chair.

Her support for DFA’s structure may boost the prospects of National Economic Council Director Gary Cohn for the nomination.  Cohn has made strident statements against parts of DFA such as Orderly Liquidation Authority, the fiduciary rule, and capital requirements.  An appointment to lead the Fed might assuage any ambivalence of Cohn’s about serving the President as NEC director after chiding Trump for his post-Charlottesville comments.

How would the Fed look under a Chair Yellen vs. a Chair Cohn?  The two couldn’t be more different stylistically and substantively.  Yellen is a deliberate academic, the customary background of  Fed chairs.  Cohn is described as an instinctual thinker.  During the campaign, both Trump and Cohn criticized Yellen’s holding down interest rates for too long, but each maintain general support for loose monetary policy.  Other than his generic de-regulatory leanings, Cohn’s views on Dodd-Frank are not well-known.  We have more specific.  expectations he would promote greater supervisory changes than Yellen.

At a confirmation hearing, Cohn would no doubt be pressed for his views on the two chief assertions Yellen made regarding DFA at Jackson Hole — that it has contributed stability to the nation’s sustained economic recovery since its enactment in 2010 and has increased rather than retarded bank lending and economic growth.

Strong Evidence of Gains

Yellen pointed to specific indicators the financial system is healthier since the passage of the Dodd-Frank Act:

  • Capital Regimes — Loss-Absorbing Capacity – Large, interconnected financial institutions have more capital as a buffer against uncertainty.  Tier 1 common equity capital is more than twice the level of early 2009 across the entire banking system, a sizable increase stabilizing bank balance sheets.
  • Living Wills —  The most important financial firms have drawn up credible living will plans and changed their capital structure in a way that improves their resolvability.  The problem of Too-Big-To-Fail has been markedly and measurably reduced as a direct result.

Director Cohn has criticized heightened capital levels, believing they choke off lending to small and medium sized businesses.   He would be at pains to contradict Yellen’s finding that, “while material adverse effects of capital regulation on broad measures of lending are not readily apparent, credit may be less available to some borrowers, especially homebuyers with less-than-perfect credit histories and, perhaps, small businesses.”   The problem is by and large confined to the housing market.

Systemic Policy Pillars

Yellen attributed the above positive indicators to specific DFA policies:

  • Stress Tests (DFAST and CCAR) — DFA mandates that each year, Fed and company-administered stress tests must evaluate the health of systemically important financial institutions.  This policy has given firms the incentive to better structure their capital positions and risk-management processes.
  • Orderly Liquidation Authority (OLA) – OLA outlines a process for the Fed and FDIC-administered liquidation of a failing SIFI.  Yellen held up OLA as the preventer of Too-Big-To-Fail, as funds used to resolve the firm must be covered by the institution’s assets.

Director Cohn is not on record criticizing these policies, but may be inclined to oppose stress tests as too burdensome for banks.  He may also be aligned with Hensarling Republicans who believe OLA codifies, rather than eliminates Too-Big-To-Fail on the grounds that the systemic risk titles of DFA will be disregarded in a crisis.

Chair Yellen acknowledged that policymakers cannot rest on DFA’s laurels.  She outlined the following issues that need to be addressed:

  • Rules for Community Banks —Yellen did not specify which rules affecting smaller banks she would recommend changing, but legislation has been discussed in the Senate to except these institutions from escrow requirements, certain mortgage rules, and the Volcker Rule. It is widely understood that community banks and credit unions with fewer than $10 billion in assets are not systemically important.
  • Homebuyers’ Credit  (especially with weak histories) —  Yellen took this opportunity to expand on arguments about the relationship between high levels of capital and lending/credit availability.  She argued one cannot conclusively state that high capital requirements chokes lending, particularly in an environment just after a serious financial crisis, as behavior is likely to change.
  • Leverage Ratios —  Yellen cited a need to review supplementary leverage ratio with risk-based capital requirements – The SLR is meant to be a support to risk-based capital requirements. It limits the amount of leverage a bank may take on using a non risk-based measure. The rule is meant to account for the failure to accurately judge the risk of certain assets like residential mortgages.
  • Volcker Rule —  Yellen conceded that there “may be benefits to simplifying aspects of the Volcker rule, which limits proprietary trading by banking firms, and to reviewing the interaction of the enhanced supplementary leverage ratio with risk-based capital requirements.” Cohn might not disagree with this assessment.

The Cohn Factor

These are far from the kinds of critiques of DFA someone likely to win the favor of Trump might give.  Director Cohn may agree with or go further than Chair Yellen on all of the above.  He might argue the Volcker Rule should be eliminated, not merely simplified. Repealing the rule would return a sizable $1 billion in profits to Cohn’s former employer, Goldman Sachs.  He has attributed low credit availability to too-great capital holdings.  The only overlap between Yellen and Cohn are that they agree that regulations affecting smaller banks (along with big banks) should be simplified — a view that is almost universally held. Finally, Cohn might also advocate changes to the supplementary leverage ratio and risk-based capital requirements.

How far might a Chair Cohn go in promoting rollbacks of DFA?  In an interview in February, Cohn emphasized the following policy goals:

  • Increase capital availability (lending) to small and medium sized businesses
  • Decreasing regulations for banks of all sizes — Rather than focusing on relieving the regulatory burden on small institutions, Cohn stated that the burden is too great on firms of all sizes
  • Decreasing capital holdings — this aim directly contradicts Chair Yellen’s promoting a better-capitalized system of today
  • Repealing the DOL Fiduciary Standard — this rule requires financial advisors act in the best interests of their clients

The President has already nominated Randal Quarles for the post of Vice Chairman of Supervision.  Like Cohn, Quarles is bent toward deregulation, particularly of the Volcker Rule, stress test transparency, and rules affecting regional and community banks.

Yellen’s term ends in February.  At the end of July, Trump said he was considering both Cohn and Yellen for Fed Chair.   A poll of economists published by Bloomberg reveals that Cohn is more likely to be selected, though Yellen finished second. But a retirement by Yellen, an Obama appointee, would give Trump something to offer his base of support.  Trump’s decision will likely come early next year.

Yellen Stays the Course (Jun. 14)

Update 184 — Yellen Stays the Course;
The Fed in Search of the New Normal
The Fed’s broadly anticipated 25 basis point increase in the Fed funds rate announced this afternoon represents a continuation of its once-a-quarter pace of “normalization policy” implementation.  Janet Yellen has adhered to the policy since her installment as Fed Chair in 2014.  The Fed defines this policy as raising its rate in small increments three or four times a year.
What’s the takeaway?  Did Yellen or the Fed make real news today?  We consider the question from the Hill/White House perspective, the labor standpoint, the market view, and the Fed record.
Fed Perspective
Since the recession, the Fed has taken an unconventional approach to monetary policy.  At the depth of the recession, near-zero short-term interest rates proved inadequate to jumpstart the economy. So the Fed started buying massive volumes of Treasury bonds and mortgage-backed securities to drive down borrowing costs.
The economy is now at full employment (despite decreased labor force participation) and close-to-perfect inflation levels. But short-term rates have yet to return to their “normal” level.  Consequently, at its meeting in May, the Fed maintained that it would continue on its “normalization path,” without any uncertainty about the trajectory for steady economic growth.
Despite recent reports of wage stagnation and potential deflation, Janet Yellen said today, “our current system is working well.” She said inflation rates were so low in recent months because of one-off factors (price drops for wireless phone service and prescription drugs). The Fed expects inflation to move up and stay around two percent over the next two years, but plans on monitoring it closely.
Many are taking a critical stance on this decision, arguing that the Fed may be putting the country at risk of deflation based on recent trends. Yellen’s oblique rejoinder: “The rate does not have to rise all that much further to get to a neutral policy stance.” The rate hike is a thumbs-up from the Fed on the current state of the US economy but some indicators are ambivalent so analysts are divided.
To be noted — Yellen expressed support for much of the Treasury report’s policy recommendations published Tuesday, but took exception to some of its key systemic and other recommendations.
Market Perspective
•  Policy Direction —  The capital, especially bond, markets have already discounted (priced in) a 25 basis point Fed interest rate increase today, with one more such hike expected in calendar 2017. Attention will be paid to anything that suggests this market consensus forecast is wrong or that clarifies the direction of Fed interest policy later this year or beyond.
Yellen spoke at length, reaffirming the Committee’s normalization policy but emphasizing its flexibility.  Following today’s action, the market doesn’t know if the Fed will continue its pace of a 25 bp rate hike per quarter or slow to just one more hike this year, its clear preference.  Today, markets are calling two percent the new normal; the Fed says closer to three.  In the past, the Fed has eventually converged with earlier market expectations.  Markets shed about a percent across the board during Yellen’s appearance this afternoon.
•  Economic Forecasts — The Fed will publish updates of its own consensus projections for the key indicators in setting rate policy, e.g., inflation, unemployment and wages, productivity, GDP growth, etc. Any projection that is a surprise to the market or relates to sensitive data, especially on growth, is at the center of both political and market debate.
The only mismatch between the market read and Fed analysis is on the current “natural” interest rate — which the Fed now estimates at three percent while market participants say closer to two.
•  Fed Balance Sheet — The Fed expanded the total assets held on its balance from under $1 trillion in 2008 to nearly $4.5 trillion in 2014, which is roughly where it has sat since. The Fed has long expressed its intent to scale its holdings back, but nothing is known about when the deleveraging is to begin, its pace, and the extent of the Fed sell off. It is concerned that market participants may not appreciate what massive deleveraging might mean for global bond markets, where large investment flows into bonds continues unabated.
Yellen made clear that the Fed’s program to reduce its balance sheet will begin modestly, take years, and will barely move markets.
Labor Perspective
•  Unemployment — The Fed met the last two days in the context of paradoxical labor market conditions. The official unemployment rate is 4.3 percent, lower than the 4.5 percent mark the Fed predicted by the end of the year.  This low rate officially amounts to full employment — fulfilling one half of the Fed’s dual mandate for maximizing employment and stabilizing inflation.  The Board’s optimism about the labor market is sufficient to reduce its long-term unemployment rate projection from 4.7 to 4.6 percent.
•  Labor Force Participation — The unemployment rate should not satisfy regulators on its own. Last month, the labor force participation rate fell to 62.7 percent.  From the late 1980s to the onset of the Great Recession in 2007, the rate stood at or around 66 percent.  Still, the rate has been stable since June 2014, which Yellen reads as a sign of improving conditions in the context of an aging US population. Yellen believes further that consistent job gains of 160,000 per month are sufficient to accommodate new entrants to the labor force. Yellen pointed to the following indicators to demonstrate the labor market’s health:
– Household perception of the availability of jobs
– Number of job openings
– Rate at which Americans quit their jobs to pursue new opportunities
– Increased business investment and hiring
•  Job Training — In response to a question soliciting her views on Pres. Trump’s proposals to cut job training programs, Chair Yellen indicated she believes state- and locally-administered training programs work. It is important to note that many federal programs create funding streams for such local entities. Therefore, cuts to these programs imply the abandonment of effective state and local training programs. Her reference to the non-for-profit sphere can be read as a surrender to inevitable administration cuts to critical job training programs.
•  Wage Growth — Wage stagnation may have given the Fed pause in its deliberations on raising rates. Increasing interest rates could damage worker wages, as more expensive borrowing could mean businesses opt against boosting pay. Yellen hinted at concern for the labor market by referencing a long span over which inflation has failed to meet the Fed’s 2 percent target.  Wage growth has historically been closely tied to inflation, so low levels of inflation suggest low levels of wage growth.  Yellen did mention in her testimony today that inflation is having little to no effect on wage growth and vice versa.
In response to concerns, Yellen has cited Federal Reserve Bank of Atlanta data demonstrating a rise, albeit slow, in wage growth to over 3 percent — up from 1.6 percent during the trough of the Great Recession.
Political Analysis
Yellen and Trump, after his less-than-amicable comments about her and the Fed during the campaign, seem to have struck up a functional relationship. In April, he didn’t rule out re-appointing her as Chief at the end of her term next February. But he praised her as a fan of “low rates” and the president can’t be happy about the prospect of uninterrupted rate hikes through his term.
One of the reasons the Fed may have waited on raising rates at its previous meeting in May is that, at the time, markets expected one of more outsized Trumpian stimulus bills (tax reform or infrastructure spending) to clear Congress. Over the last couple of months, it had become inescapably clear that both are letting that promise fall to the wayside. Today’s move by the Fed confirms this view.  The Fed did not want to be in the position of having to blunt the effects of a macro-economically gratuitous stimulus when the recovery glass was half-empty.  Today it is half-full.

The Fed Rate Debate (Mar. 14)

Update 169 — The Fed Rate Debate

Does Political Risk Deserve Any Weight?

As you probably know, the Federal Reserve announcement tomorrow afternoon is expected to confirm an all-but-promised 0.25 percent interest rate increase.

On what basis is Fed acting in this instance?  What is the role of the economy, the markets, and politics in its rate decision?  What are the underlying assumptions behind a hike and what do they imply?  Are political circumstances properly weighed as an input?

This is what we explore today, below.




The Federal Reserve is set to make a decision on interest rates tomorrow, taking many factors into consideration. The new job report, which boasted a 4.7 percent unemployment rate and an uptick in the labor force participation rate, was a sign of a healthy economy.  A surging stock market with a healthy job report point to signs that there will be a rise in interest rates.

Yellen’s Choice

Federal Reserve Chair Janet Yellen, historically cautious, seems to have been pushed by extraordinary circumstances to make this move, the second rate hike in the past ten years. Per American Prospect:

Yellen has brilliantly bobbed and weaved, in the manner of Fed chairs, suggesting that the Fed would surely raise rates sometime soon, but not quite yet.  But the pressure among other Fed governors and regional Fed bank presidents has reached the point where even Yellen has had to join the inflation-hawk camp, lest she get outvoted on the Fed’s policymaking Open Market Committee—a fate that Fed chairs detest.  


But is the rising trend in the market a stable trend, or will it fall in self-correction should the administration fail to produce legislative results and enact its policy agenda?   If the Republicans, who yowled and moaned for the past seven years about the ACA, and Trump cannot successfully pull off a swift and comprehensive ACA repeal or even a viable reform, then how will they be able to come together and follow through on the rest of their agenda?


This raises the question: what bets are the Fed making on Trump and the Republicans and their efficacy?

Will Trump’s Program Succeed, Legislatively and Economically?


Given that the Fed’s choice to raise rates would indicate that the market growth is not an anomaly prone to instability or the impulse to self-correct, and given that the market growth seems to be directly tied to political confidence in the virility of Trump’s agenda: does this mean that Yellen and the Fed tentatively believe that the Trump administration will be able to achieve their policy goals as presented to the watching world?


In recent remarks, Yellen has emphasized the risk of rising prices, she has also remained committed to raising rates at only a “gradual” pace in order to leave loose policy in place a while longer.


But given that Speaker Ryan’s American Health Care Act appears to be dead-on-arrival, is the Fed making the mistake of taking its cues from a market that might be overpricing itself based on unfounded political optimism?

The Blue Collar Worker

The market isn’t alone in its optimism:  blue collar workers also continue to be optimistic about the future of the Trump presidency, according to polls.  Although the Trump administration has had little time to make any substantial policy changes, the expectation of a reduction in taxes and regulations and the possibility of vast infrastructure spending have created optimism among employers and blue-collar workers.  President Trump has promised to expand the economy by four percent a year, create 25 million jobs in the next decade, revive manufacturing and reduce the trade deficit.

Achieving all that would be difficult in the best of circumstances, let alone with the potential headwinds facing the White House.  Dissension among Republicans and the unpredictability of Trump’s course in several policy areas could dampen job growth.

Current Economic State of the Union

Beyond the financial markets, Yellen’s decision will be informed by a labor force that is experiencing wage growth for the first time in decades. Unemployment is down to 4.7 percent and labor participation ticked up to 63 percent last month.  Median household incomes and average wages are on the rise as well. The labor force is a sign of a somewhat healthy economy and serves as an example Yellen might use as to why the economy is ripe for increasing interest rates.

Given her proposed gradual increase of interest rates, Yellen might be assuming that the economy will be robust under the Trump administration, fueled by spending and tax cuts with no major changes in employment numbers.  If you think the economy is on a healthy trajectory, Yellen’s interest rate hike will not surprise.

Political Risk

But given the uncertainty clouding the Trump administration on every issue, especially the economy, that analysis may be discounting a risk that looks more likely by the day.  It’s the political risk that the program won’t get enacted.  Or that if it does, it might fail in practice.  That the result might be American buyer’s remorse to a degree that ultimately triggers a reversal of fortune and a broad sell off in the markets, constraining, not fueling growth — not circumstances calling out for a rate hike.