Episode 17 - Trump and the Fed

How the next president of the United States will affect the Federal Reserve. A short episode on the impact of a change in political party in the highest ranked position in the free world.

Intro

Welcome to The Bankster Podcast. I’m your host, Alexander Bagehot, and this is Episode 17 - Trump and the Fed. Every episode we dive into the intricate world of central banking! I use one or two pieces of news from the Federal Reserve or monetary policy from around the world to summarize, translate, and explain a few points from the Centralverse. Now the Centralverse is the deep, the fascinating, the ever changing, and the incredibly consequential world of central bankers and the economies they attempt to support.

Most of the world was surprised as Tuesday night turned into Wednesday morning and Donald J Trump was leading in the race to become the next president of the United States of America. Prediction markets, polls, and pundits a like had all predicted a pretty clean Hillary Clinton victory. However, before the morning had broken, Hillary had called to cede the race and congratulate Trump for winning. I had planned on doing this week’s episode on the term “Quasi-governmental” and the makeup of the board of directors of the Federal Reserve Banks, but it seems more appropriate to push that one back to next time.

One inevitable question that has bounced around every family, household, business, and group around the world is, “How will Trump’s victory impact me or us?” Well, the Federal Reserve, as an institution, does not answer this question. In fact, at least for the past few elections, they have not released a press statement in regards to the results of the race period. So I have spent the last few days looking into how the Federal Reserve is impacted by a change in the US Presidency. There is quite a bit being written about this now and will be in the coming days and months. On this episode I’d like to summarize the main impacts by breaking them down into three main areas: (1) Interest rates and everything that goes into deciding where they should be, (2) Senior leadership positions at the Fed, and (3) Regulatory laws and how they are enforced.

As a quick side note before we dive in, I woke up with a terribly sore throat. So if my voice cracks or sounds a bit echo-y I apologize.

Interest Rates

So let’s start by talking about interest rates. Controlling the general level of interest rates, low or high, and the direction of interest rates, going higher or going lower is one of the most important policy tools that the Federal Reserve has to accomplish its goal of maintaining a healthy economy. The next opportunity that the Federal Open Market Committee, the FOMC, will have to make a decision about interest rates will be at their meeting in the middle of December. Through the communications of the members, from speeches and the published meeting minutes we can get an idea of what they are thinking. A thorough reading of the notes and statements shows a pretty strong possibility of an interest rate increase at the December meeting. How has this thinking changed since the election? Well, we don’t really know yet, but here’s what I was able find.

The members of the FOMC did not mention the presidential election directly in the meeting notes thus far in the first six meetings of the year. However, we still don’t have the meeting notes from the most recent, November 2nd meeting. So no hints from the official meeting minutes.

I then looked at all of the recent speeches by the 17 members of the FOMC, and only two of them have spoken since the election on Tuesday: James Bullard of the St Louis Fed and Neel Kashkari of the Minneapolis Fed. President Bullard’s speech was well prepared and scripted before the election - he spoke on a mathematical equation he uses when thinking about what the interest rate should be, but he mentioned nothing about the election. Neel Kashkari spoke at a slightly more dynamic event, a Question & Answer series at a small Wisconsin town’s Chamber of Commerce. Kashkari was asked about the impacts of a Trump presidency on the Fed and he gave a pretty generic response, ““The Congress has said to the Fed we are going to leave you alone to set monetary policy and not interfere, and the quid pro quo is we are not going to get in their business. We have worked very hard to steer clear of anything in terms of partisan politics.”

This is pretty standard. Don’t expect to hear Fed officials get very involved in partisan politics or make any strong comments in regards to the results of the election. However, one thing that the Federal Reserve does talk about a lot is uncertainty. In fact, Lorreta Mester, President of the Cleveland Fed, dedicated her most recent speech entirely to the topic of making monetary policy in an age of uncertainty. And one thing that a Trump presidency brings is a lot of uncertainty. Markets’ knee-jerk reaction was to sell sell sell. Asian markets, opening in the early morning US time dropped significantly, the Japanese exchange quickly lost nearly 6%. However, by the time the markets opened in the United States investors sentiments had reversed their course and both US and European markets ended higher. This increase in volatility is expected when something unexpected happens.

Luckily for the FOMC they still have a month before the meeting in December when they’ll have to make their interest rate decision. They’ll be able to see how the short term indicators like financial markets react after the initial shock of a future Trump presidency wears off.

So to our first of three questions of the day, “How will Trump affect the next interest rate decision?” Here’s my take. It won’t have a much of an impact. Don’t count on the Fed breaking its tradition of keeping partisan politics at arm’s length. Instead of directly referencing the election they will mention “uncertainty” in the economy, which has increased because Trump won. However, interest rates are still very low, and most believe that the Fed will continue with their interest rate hike in December. The futures market still have the probability of a Fed rate increase in December at 72%.

Ok, on to impact number two - Senior leadership at the Fed.

Senior leadership at the Fed

Although the President of the country and the federal government in general do not have a direct hand in the decisions about interest rates, they do have a direct hand in choosing who some of those people at the meeting are. Each of the Governors of the Federal Reserve are nominated by the President and confirmed by the Senate. This is where President Trump will have the largest direct impact.

There were initial rumblings when Trump was pulling ahead that Janet Yellen, the current Chair of the Board of Governors and highest ranked Fed official, would maybe step down when Trump takes office. This is highly unlikely. Chair Yellen has spent her career at the Fed and takes the independence of the Fed very seriously. She would be sending a very political message by stepping down.

Trump has made both gracious comments about Chair Yellen, saying, “Look, she’s got a term to go. I have great respect for her. I don’t know her but I have great respect for her.” He’s also said some pretty unsavory things about her like, “I think she is very political and to a certain extent, I think she should be ashamed of herself.” The Wall Street Journal has a great article out there that lists all of the comments Trump has made in the last year about interest rates and Janet Yellen. As is the case on a lot of issues Trump has spoken on, there is a very wide range of opinions he has expressed. Who knows which Trump will show up on Inauguration Day.  But it would be surprising and unprecedented in recent times if Trump tried to bully Chair Yellen into changing policies. The Wall Street Journal reported on Wednesday that an economic advisor to President Elect Trump said that they will not seek Yellen’s resignation. When her term ends in February of 2018 it is unlikely that then President Trump will reappoint her to the position. Although he can remove her from being Chair he cannot remove her from her position as governor, which does not end until 2024, but a Chair has only stayed on as a Governor after being removed as Chair twice in the 100+ year history of the Federal Reserve. And the most recent case was Marriner Eccles in 1948 (see Episode 7 for more info on that story).

So we can be nearly certain that Yellen would leave the Fed if not reappointed. Trump would then be able to appoint a new Governor and choose that new Governor to be the Chair of the Board. So that’s one appointment that Trump is sure to make to the Fed. Vice Chairman Stanley Fischer is also likely to leave when his term ends in mid 2018.

However, there are currently two other open Governor positions at the Fed that Trump could nominate on his first day in office. Those positions have been vacant since 2014 and with a Republican controlled Senate it seems likely that these positions will in fact be filled by President Trump. This won’t directly affect the other 12 members of the interest rate setting committee, the presidents of the Federal Reserve Banks spread out across the country. However, as you’ll learn on the next podcast episode, it will affect the board of directors at each of those banks, and they’re the ones that choose each Reserve Bank’s president.

So to our second of three questions of the day, “How will Trump affect the senior leadership of the Fed?” Here’s my take. Quite a bit. In two years from now at least 4 of the 7 board of governors will be President Trump appointees. How they will affect the workings of the Fed is, at this point, completely unknown.

Ok, on to impact number three - Regulatory laws

Regulatory Laws

This isn’t the time to go into deep details about all of the potential impacts of all of the potential laws that the new Republican congress may pass and President Trump may sign. So instead, I’ll just list and briefly explain a few that are likely to come up and be debated.

The first and potentially most impactful is a law from the “Audit the Fed” camp of ideas. Go back to Episode 8 to hear more about this question of the Fed being audited. But basically what an Audit the Fed bill would do is take away some or all of the independence of the Federal Reserve. Most bills in this camp want to set limits, restrictions, or requirements on how the FOMC chooses what interest rates will be.

Another camp of bills that might come up under a Trump presidency is new or amended Financial Regulation acts. After the Great Recession of 2007-2009 congress passed the Dodd Frank Wall Street Reform and Consumer Protection Act. The new Republican controlled government may decide to reopen the act and make changes to how banks and financial institutions are regulated and who regulates them. Operationally this would have a very large impact on the Supervisory role that the Federal Reserve plays in the economy.

The final camp of bills that I’ll mention today is fiscal stimulus packages. This might include spending on infrastructure and the military as well as tax cuts. Remember that when interest rates are low the Fed is providing monetary stimulus to the economy. So if the government begins to add stimulus from their side, the Fed may feel more comfortable rising interest rates and decreasing the Fed’s stimulus.

Those are a few of the bills that will most definitely be debated under a Trump presidency. We’ll see how involved his administration is in shaping government economic policy and what bills actually make it to his desk to be signed.

Conclusion

Well, this episode turned out to be about the same length as all the other episodes. I’m sure this won’t be the only episode I do on the impacts of the Trump Presidency, but I hope that this was a good starter for those of you wondering what the future of the United State’s Central Bank may entail. And for a quick review the biggest areas of impact are: (1) Interest rates and everything that goes into deciding where they should be, (2) Senior leadership positions at the Fed, and (3) Regulatory laws and how they are enforced.

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Today’s episode was written, edited, and produced by me, Alexander Bagehot. I dedicate this episode to President Elect Donald Trump - may you surround yourself with wise counsel and succeed in improving the economy for all of its members. And to everybody else, thanks for listening. I’m Alexander Bagehot, and I’ll see you next time on The Bankster Podcast!