When the Federal Open Market Committee (FOMC), the Fed's rate-setting committee, meets from December 13 to 14, chances are nearly 95% that it will vote to raise interest rates by a quarter percentage point to a target range of 0.5% to 0.75%.
That comforting certainty, courtesy of the CME Group's federal funds futures tracker, breaks down quickly when Donald Trump's incoming administration takes the reins. The president-elect accused the Fed of stoking a bubble in August 2015, switched to extolling the merits of low interest rates the following May, then in October accused Fed chair Janet Yellen of "doing political things" by offering low rates as a sop to the Obama administration. To get a sense of what kind of central bank we can expect during the Trump administration, Investopedia spoke to Danielle DiMartino Booth on November 22. A former advisor to the Dallas Fed, Booth is the author of "Fed Up," a book criticizing the Federal Reserve System that goes on sale February 14th, 2017.
The incoming administration has promised the largest tax change since Reagan and $1 trillion in infrastructure investment. While the final shape this stimulus will take is anyone's guess – Congressional Republicans could remain fiscally hawkish – optimism regarding the plan has yanked up Treasury yields and inflation expectations. Many forecasters expect economic growth to accelerate as well, although not to the 4%, 5% or 6% Trump has promised. All of these factors suggest higher interest rates. (See also, Is Trump the Next Reagan? Investors Brace Themselves.)
Asked if she bought this narrative, Booth burst into song – "happy days are here again…" (Ironically, the theme for a Democratic presidential campaign; appropriately, the campaigner was Franklin Delano Roosevelt, author of American history's most ambitious stimulus package.)
In other words, "no, because starting points matter, and we are at a completely different juncture." When Reagan came into office, Booth pointed out, the S&P 500's price-to-earnings (P/E) ratio was in the single digits; according to multpl.com, it was just over 9.0 at the beginning of January 1981. Today, by contrast, we are at "the tail end of one of the longest expansions in post-war history" and the S&P's P/E is nearly 25.4. Interest rate outlooks that assume Ronald Reagan's third term will begin in 2017, in short, may not play out. (See also, Trumponomics: Economic Forecasts.)
Which Trump Do We Get?
Asked whether we can expect Trump to return to his previous embrace of low rates, Booth linked his inconsistency on monetary policy to the shake-up of his campaign staff in May. "Before he fired his campaign manager he's like hey, I'm a debt guy. Low interest rates good, high interest rates bad." After he replaced Corey Lewandowski as campaign manager in June – first with Paul Manafort and then, in August, with Kellyanne Conway – Trump changed his tone, tapping into the feeling that "the Fed had been doing the Obama administration's bidding for the last eight years."
"I happen to agree with that," Booth added, pointing out that Lael Brainard donated the maximum amount of $2,700 to Hillary Clinton's presidential campaign and that Daniello Tarullo put an Obama sticker on his car. Both are on the Board of Governors, meaning they have votes on the FOMC. (See also, The Federal Reserve: Introduction.)
How Much Can Trump Do?
Given that Booth ascribes Trump's pronouncements on monetary policy more to campaign strategy than conviction, she is not certain what shape the Fed will take over the next four to eight years. She'd been excited when the election results first came in, since there was reason to believe Trump's win would "imply a much different Fed going forward." Over the following two weeks, though, Trump became "more genteel," leading her to wonder whether he'll be the force for change his late-stage campaign rhetoric would suggest. (See also, How Trump Could Quickly Shake Up the Fed.)
He certainly has the opportunity to reshape the FOMC. There are currently two open seats on the committee, both reserved for governors. The Board of Governors accounts for seven of the FOMC's 12 votes when politics allows (no one has even mentioned Obama's two forlorn nominees since March). One vote goes to the New York Fed president, William Dudley, who also serves as the committee's vice-chair. The remaining four go to an annually rotating group of regional Fed presidents.
|2017 Federal Open Market Committee voting members|
|Janet Yellen||Board of Governors chair, FOMC chair||Feb 2018 (chair), Jan 2024 (board)|
|William Dudley||New York Fed president, FOMC vice-chair||2027 (mandatory retirement age = 75)|
|Stanley Fischer||Board of Governors vice-chair||Jun 2018 (vice-chair), Jan 2020 (board)|
|Lael Brainard||Governor||Jan 2026|
|Jerome Powell||Governor||Jan 2028|
|Daniel Tarullo||Governor||Jan 2022|
|Charles Evans||Chicago Fed president||End 2017|
|Patrick Harker||Philadelphia Fed president||End 2017|
|Robert Kaplan||Dallas Fed president||End 2017|
|Neel Kashkari||Minneapolis Fed president||End 2017|
|Source: Federal Reserve Board|
Trump might have even more leeway to appoint like-minded FOMC members. Yellen told Congress on November 17 "it's fully my intention to serve out" her term as chair of the Board of Governors, and Booth "cannot foresee a set of circumstances that would force her to step down" sooner. But that term expires in February 2018, and Stanley Fischer's term as vice-chair expires the following June. If both step down, Trump would have the opportunity to nominate four of the seven governors during his first two years, subject to Senate approval. (See also, Yellen's Future with the Fed After Trump Win.)
On the other hand, there is no guarantee that Yellen and Fischer leave the board when their leadership terms expire. Yellen has a board seat until the end of January 2024, though the usual pattern is for outgoing chairs to leave the board when their successors take over. Fischer is serving out a predecessor's term, which ends in January 2020. He could conceivably begin another 14-year stint if reappointed, which would carry him through to age 90. Also worth considering: if push comes to shove, the law allows Trump to remove a board member "for cause."
Trump's charge that Yellen is acting politically has led to hand-wringing over the central bank's future independence. Former Minneapolis Fed president Narayana Kocherlakota wrote shortly after Trump's victory, "there is absolutely nothing in U.S. law preventing Trump from violating the Fed's independence, a post-1979 development that rests largely on the restraint of the president." In Booth's view, however, the Fed is already "political in an overt way."
What Needs to Change?
Assuming that Trump does get "the opportunity of a lifetime" to appoint four governors – Booth's phrasing – what kind of changes would she like to see?
First, that Trump recognizes "the futility of econometrics and designing monetary policy based on models and theories that don't necessarily apply on planet Earth." The corrective to this "throwing spaghetti at the wall methodology" is picking the right people. The current FOMC, in her view, is stacked with academics who enjoy lifetime defined-benefit plans and, as a result, "don't have to eat what they cook." She thinks CEOs, pension fund managers and others who understand the implications of zero interest rate policy are better suited to the job than Ph.D.s.
She cautions that the answer is not necessarily higher interest rates, however. If the Fed forces a recession, "which I think they might do," rates are unlikely to rise regardless of the board's composition. But in any case, she argues, certain lessons need to be learned: "the zero bound should never be breached again, and we should always at least aspire to have curve in our yield curve." That means taking financial markets into account, as well as the rest of the "complex, adaptive system" Booth says the Fed too often ignores, creating models as if they operated "in a vacuum." (See also, Buffett on Dodd-Frank, the Fed and the National Debt.)