Article

Inflation and Federal Reserve politics

The board of the Federal Reserve could change significantly in coming months, this means a major shift in policy is unlikely any time soon.

| 7 min read

US inflation hit 6.2% in October, far higher than the Federal Reserve Board's forecasts earlier this year. It was not just energy prices, but also rents and car prices that were particularly buoyant. It looks as if inflation will both go higher and last longer than the Fed has been telling us.

As we have been warning, the US decided on a much larger monetary boost than other leading countries, at the same time as a double government boost with the Trump and Biden packages of extra spending and borrowing. It is having a visible and not surprising impact on prices, as the economy strives to get back to work and to tackle a series of shortages in everything from energy to truck drivers and from microprocessors to finished cars.

Some market commentators are expressing surprise that the Fed has not done more to recognise the overshoot and to take some counter action. They should look at what is happening around the Board table. The current Chairman Jerome Powell has still not been reappointed by President Biden, though his term runs out early next year. Many in the markets expect he will be retained, even though he is Republican by background. The Treasury Secretary after all has said he has been doing a good job. Many think that there is a clear case for continuity to reassure markets.

  • 6.2% US inflation in October

Some market commentators are expressing surprise that the Fed has not done more to recognise the overshoot and to take some counter action. They should look at what is happening around the Board table. The current Chairman Jerome Powell has still not been reappointed by President Biden, though his term runs out early next year. Many in the markets expect he will be retained, even though he is Republican by background. The Treasury Secretary after all has said he has been doing a good job. Many think that there is a clear case for continuity to reassure markets.

The left wants to reshape the Fed

The left amongst the Democrats, led by Senator Elizabeth Warren, want Powell out. They are critical of his support for some banking deregulation and favour a chair who would be much tougher on the commercial banks. They also wish to see more enthusiasm to use the Fed to promote strong climate change and social policies. They are not critical of Mr Powell's policy of treating inflation as a short-lived problem and continuing with substantial support for the economy. They want that. The chairman's judgement that there is no hurry to rein in all the bond buying, let alone put up rates, will be popular with those who influence the decision on his future.

The board itself is in a state of flux.

Mr Powell too is answering for his own investments and putting in place a tougher regime. The board itself is in a state of flux. The vice president for banking regulation, Randal Quarles reaches the end of his period in that office and has decided to retire from the board as well at the end of the year. Vice Chairman Richard Clarida also reaches the end of his term and will probably leave the board. This means there needs to be a general restructuring, with two new vice chair and maybe a new chair, as well as several new members of the board.

Senator Warren and her supporters promote Lael Brainard as a possible new chair or vice chair for banking regulation. Lael Brainard has written and researched ways of controlling banks more strongly. A number of Democrats from Congress want to see a more diverse set of appointments to the Federal Reserve board and the regions, recruiting from a wider ethnic background and choosing people who want the central bank to do more to promote decarbonisation and diversity.

If President Biden decides in the end to resist criticisms of Jerome Powell from the left he may well expect the chairman to tilt towards the new agenda for the Fed, and to do more to promote diversity, greenery and other social causes. He might also wish to see Lael Brainard in the bank regulating role, where she would wish to push Mr Powell into a new stance on the issue. Were the President to appoint a Democrat nominee to the chair then such a person would also be likely to be driving these agendas.

Holding steady

Given the continuing uncertainty over who will be round the table and who will hold the two vacant vice chair positions, it is unlikely the Fed is going to make any major changes to policy during this interregnum. As a result, all those who want urgent tougher action against inflation are likely to be disappointed.

Behind the scenes, any Fed member doing their job would be wise to worry.

Although the Fed will now have to acknowledge that it underestimated the magnitude and duration of higher price rises, it is likely still to see this as temporary responses to a series of supply shortages. The Fed does not take a monetarist view and is not about to say it expanded money too far too fast, and the politics do not work in favour of donning a hair shirt yet. The Fed will continue to assume inflation does not embed in an inflationary wage round.

Behind the scenes, any Fed member doing their job would be wise to worry. They need to watch the way rents are rising, and to see how wages develop against the background of high increases in the headline inflation rate.

In current conditions there is more inflation to come. They hope that more people make themselves available for work, as there is a shortage of people for all the vacancies. They will forecast that productivity will perk up, with a higher investment rate as companies wrestle with shortages by committing more capital and machinery. Maybe energy prices will subside as more supply becomes available. Maybe more people will decide they need jobs. Most forecasters think inflation will come down next year.

The uncertainties around the leadership of the Fed do increase the risks. In the short term, it means further delay in taking corrective action to tighten financial conditions to curb price rises. In the longer term there is a battle for the soul of the Fed. What is likely to emerge is a Fed that accepts a bigger role for itself in regulating banks and influencing the economy, as well as a Fed which remains happy with the swollen balance sheet it has adopted during its pandemic response.

The Fed will remain very important for the future of the US economy, but it will not always be helpful to the banks and the wider private sector. The Democrats want it to be an activist bank, correcting the excesses and errors as they see them of the private sector whilst promoting a larger public sector. This is a negative for the market in general, as it reduces confidence in the institution which saved the financial markets in March 2020.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Inflation and Federal Reserve politics

Read this next

US inflation at 30-year high

See more Insights

More insights

Article
Omicron and hawkish Fed concern markets
By Garry White
03 Dec 2021 | 6 min read
Article
Why markets have fallen
By Charles Stanley
01 Dec 2021 | 4 min read
Article
New Covid-19 variant hits travel and markets
By Garry White
26 Nov 2021 | 7 min read
Article
Pandemic savings to boost Black Friday, but what then?
By Charles Stanley
26 Nov 2021 | 5 min read