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Is The Fed Still Independent?

Jerome Powell.
Federal Reserve Chairman Jerome Powell. Photo courtesy the Federal Reserve.

The United States Federal Reserve has a central place in global commerce, largely because it remains separate from political maneuvering. But the first few months of 2019 have marked a shift in the Fed’s outlook, raising the specter – though not the certainty – of government interference.

Since the end of 2018, the previously hawkish Fed has taken a pronounced turn for the dovish. In late March, the central bank’s Open Market Committee opted to leave its target rate unchanged, at 2.25% to 2.5%. At the same meeting, more than half of the members of the committee signaled that they do not expect any further rate hikes in 2019; as recently as December, most observers expected between two and three over the course of the year. If anything, the market may have priced in rising odds that the Fed will actually cut interest rates before 2020.

This shift may simply reflect a cautious approach to fundamentals. February’s job report indicated only 20,000 additional jobs, though employment bounced back with 196,000 jobs in March. In addition, the first quarter reflected lowered expectations of economic growth, slowing business investment and reduced household spending. Yet Federal Reserve Chairman Jerome Powell stressed in March that U.S. economic data is still strong overall.

As my colleagues and I have observed in the past, steady economic times are the perfect opportunity to raise interest rates from historical lows. Raising rates back to normal levels, among other things, gives central bankers ammunition whenever the next recession arrives. At our current interest rate levels, there would be little room to lower them if we needed to do so in reaction to a serious downturn.

Despite this reality, a significant portion of investors and analysts have celebrated the Fed’s reversal on its previously planned rate hikes for 2019. Why? There may be a variety of reasons, but I wonder if Americans have been affected by a particular, very loud critic of interest rate hikes – one who happens to occupy the White House.

Donald Trump broke years of presidential tradition in 2018 when he openly criticized the Fed, but once he had done so, he was not shy about repeating and amplifying his displeasure. Last summer, Trump continued to maintain that Powell was a good choice despite his frustration at the Fed’s actions, but by November, the president told CNBC he was “not even a little bit happy” with Powell’s appointment. In December, Trump went so far as to threaten to fire Powell. Powell countered by stating he would refuse to resign. (Whether Trump has the power to fire Powell at all is not entirely clear.)

After the market turbulence that marked December 2018, however, I noticed a shift – one in which others, too, have started to wonder if the Fed had raised rates too quickly or too far. Interest rates remain low by historical standards, even after four increases last year. Raising them by a mere 0.25% at a time should not stop healthy business enterprises from proceeding with their plans for investment or expansion. Yet as recently as April 5, Trump publicly called on the Fed to cut interest rates in order to boost the economy. I wonder if the public reaction to such demands has changed over the past nine months, seemingly through pure repetition of the president’s opinion.

Whether Trump has influenced the American public’s perception of the way interest rates should move, however, is less critical than whether he has influenced the Fed’s outlook. The Federal Reserve is designed to be an apolitical organization, independent and self-contained. Its focus should rest on exactly two factors: inflation and unemployment. With both very low, now should be the perfect time to pursue normality after years of abnormally low interest rates.

That said, a pause in raising rates may be warranted. The yield curve inverted in March, which has raised concerns of an oncoming recession for many investors, though the particulars of this inversion differ in some ways from the historical examples this fear is based upon. And, as Boston Federal Reserve President Eric Rosengren observed in a speech in March, lingering uncertainty over the state of trade with China has made it difficult to make accurate economic forecasts. Perhaps the Fed is simply being cautious. But a pause in raising rates is not the same as stopping indefinitely, or even cutting rates in the future. If the Fed went as far as cutting rates, absent any major changes to the economy, I would be alarmed.

Also potentially concerning: Trump’s two intended nominees for open seats on the Fed’s board of directors. The first, Stephen Moore, is a political commentator who served as an economic adviser to Trump’s presidential campaign; the second, Herman Cain, ran his own ill-fated presidential campaign in 2012. Moore’s critics point to his history of making fundamental data errors and a tendency to ignore facts that don’t support his positions. He has also called for Powell’s removal. Cain, a restaurant industry executive who served as an adviser to the Federal Reserve Bank of Kansas City in the 1990s, has advocated a return to the gold standard and has said that the Fed’s principal mandate – keeping unemployment low and controlling inflation – doesn’t make sense. Cain also faced a string of sexual harassment allegations that effectively ended his presidential run. (He has repeatedly denied the allegations.) Moore, for his part, is the subject of a $75,000 lien from the Internal Revenue Service, which he claims is the result of an error by the government.

Trump has previously nominated four Fed officials, including elevating Powell from a governor to chairman. But all of his previous nominees were uncontroversial choices, with backgrounds that matched that of a typical Federal Reserve appointee. Cain and Moore are much more unconventional and partisan choices, and both men have generated serious pushback from economists and policymakers even before either has been officially nominated. The editorial board of the Financial Times went so far as to state that the potential nominations of Moore and Cain “surely qualify as sabotage.” In the context of Trump’s ongoing frustration with Powell and the Fed generally, it is hard not to read these two potential nominees as a shot across the bow.

Other countries offer several recent examples of what interference with central banks looks like. Long-standing conflict between Indian Prime Minister Narendra Modi and the Reserve Bank of India came to a head in November, when information surfaced that the government planned to exercise previously unused powers allowing it to give “directions” required in the “public interest” to the central bank. A meeting later the same month ended in an impasse, according to some analysts, and the bank’s president resigned shortly after. Moody’s Ratings Agency recently lowered Turkey’s credit rating, citing concerns about the Central Bank of Turkey’s independence; the bank used its reserves to prop up the lira ahead of a round of significant elections. This follows a year in which President Recep Tayyip Erdogan appointed his son-in-law as finance minister and pressured the bank to hold down interest rates. Philippine President Rodrigo Duterte recently appointed a political ally and former cabinet minister head of his country’s central bank.

In all of these cases, political meddling has undermined confidence in the corresponding country’s currency and economy. I’d say we have a long way to go before we are in the same boat as India, Turkey or the Philippines. Yet a lack of confidence in the U.S. central banking system could eventually have severe consequences for the dollar and the way that our markets are perceived abroad.

The Federal Reserve will meet again at the beginning of May. We will have to wait until then to see what the central bank will do – or not do. But regardless of where you think interest rates should go next, preserving an independent Fed should be high on everyone’s list of priorities.

Vice President and Chief Investment Officer Paul Jacobs, of our Atlanta office, contributed several chapters to our firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55, including Chapter 12, “Retirement Plans;” Chapter 15, “Investment Approaches and Philosophy;” and Chapter 19, “A Second Act: Starting a New Venture.”

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