On Monday, February 5, as Jerome Powell took the oath of office in Washington as the new chairman of the Federal Reserve, a quick Acela ride north, Wall Street was experiencing its worst one-day slide since 2011. Talk about a made-for-TV split screen.
For the stock market, the day signaled the start of volatility not seen in some time. For Powell, it was the ceremonial kickoff to his first official day as the face framing how the Fed navigates current economic fundamentals.
Powell inherits a robust economy, a tight labor market, and signs of wage inflation. How he responds will help shape the economy’s health, the market’s lasting vitality, and where investors might turn to reach their investment goals.
Getting to know the new chairman
Powell doesn’t fit the recent mold of Fed chair. He achieved unquestioned success as an executive at the Carlyle Group after finishing his law degree, a noted difference from the PhD in Economics held by his four most recent predecessors.
But unlike the President who appointed him, Powell isn’t coming to the position as an outsider. He spent the last five years on the Federal Reserve’s board of governors and was viewed in many circles as the choice of continuity and a close ideological ally of the chair he replaced, Janet Yellen.
While on the board of governors, Powell voted lock-step with the consensus on the Federal Market Open Committee (FOMC) on influential decisions like quantitative easing and basement-level interest rates.
Other than those votes, market observers only have several interviews to study in attempting to discern – and price in – how Powell will guide the Fed during such a pivotal time in the economic recovery.
As he hits the ground running, here are three policy areas we are focused on.
The rising rate blueprint
Unlike several more hawkish finalists for the position, Powell seems comfortable with a more cautious rising rate policy. The Fed raised its short-term fed funds rate in December 2016 before three more hikes in 2017. Its tentative plan calls for three more increases this year, but tentative is the key word in an economy with many moving parts.
As Powell said at his swearing in, “Today, unemployment is low, the economy is growing, and inflation is low.” However, if the tide shifts, it’s unclear how much time Powell will give the economy or the market to sort itself out. Because, as he said moments later, “Through our decisions on monetary policy, we will support continued economic growth, a healthy job market, and price stability.”1
Prices were anything but stable as Powell took charge. The market plummeted, rebounded, and then slid into a possible correction within a week. Some say it’s inflation bringing normal volatility back to the markets after a prolonged period of calm. Yet, others wonder if Powell will react like former chair Alan Greenspan after the infamous “Black Monday” crash in October 1987.1 Greenspan immediately cut the Fed’s benchmark interest rate to reverse the slide.
This drop was less drastic, and there are no indications that Powell would reverse course and cut interest rates to prop up a mature bull market. In fact, back in 2012, he said of the Fed’s decision to suppress interest rates, “I think we are actually at the point of encouraging risk-taking, and that should give us pause.”2 That “risk-taking” led to unprecedented inflows into the equity markets as bonds suffered from low rates.
Balance sheet normalization
Unlike the path to higher interest rates, unwinding the Fed’s balance sheet looks to have few roadblocks. The blueprint starts with the Fed allowing $10 billion of maturing securities to roll off its books, eventually ramping up to $50 billion per month after one year until the balance sheet is normalized.
The end of quantitative easing may have an impact on the Fed’s interest rate policy moving forward, but in the short term, a Powell-led Fed will likely follow the plan unless economic conditions drastically change.
The fate of financial regulation
While interest rates and pricing stability rightfully get most of the headlines, Powell’s views on financial regulation will also be a topic to watch during his tenure. Despite long backing the Fed’s approach to shielding the financial system post-Recession, Powell recently made remarks that hedged his voting history and opened the door to greater deregulation.
“There is certainly a role for regulation, but regulation should always take into account the impact that it has on markets, a balance that must be constantly weighed,” Powell said at a gathering of the Treasury Market Practices Group. “More regulation is not the best answer to every problem.”3 Powell also recently noted the Fed’s plan to bring regulation of bank directors back to pre-crisis levels.4
The Trump administration has already aggressively pushed deregulation in its first year, and it now may have a similar-minded presence at the Fed.
The delicate balancing act will judge Powell’s tenure
The Fed’s constant challenge is to keep interest rates high enough to prevent the economy from overheating, while keeping them low enough to foster economic growth. Any acceleration in the Fed’s interest rate policy will be dictated in part by continued economic expansion and further signs of inflation that are already peeking into the underlying data. Another wrinkle is the murmurs of a potential Recession in the coming years, and how the Fed may proactively position interest rates to assist in any recovery.
As Powell starts charting – or staying – the course, he will likely face many questions. What if market volatility is here to stay? How much inflation is too much? Will greater deregulation put the economy back in danger? Answers will come in time.