While many forex traders are focused on what Janet Yellen will be doing next in terms of US interest rate policy, as with many other factors affecting currency markets at the moment, there is a political dimension to consider. Yellen’s term at the Fed will end early next year, and there is no guarantee that it will be renewed. On current form, there is a high likelihood that she will be replaced by someone with more business experience and less academic credentials.
On top of this, there are three vacancies on the Board of Governors and also likely to be a new vice chair at some point next summer (2018). This means up to five NEW board members on a seven member board with some of these seats potentially filled by individuals from the business world rather than academia.
According to Blu Putnam, Chief Economist at CME Group:
“Our intuition is that more business experience on the Fed Board of Governors and fewer economists will shift the debate away from academic interpretations of monetary policy and increase the focus on the interplay of rates and debt.”
For example, the high debt loads in the US could create a bias for lower than otherwise rates; a future Fed may not be keen to derail the economy with higher debt service expenses, and would therefore be more in tune with the Trump administration’s plans for US economic growth.
Putnam rightly points out that economists have been running the Fed since 1970. While men of business and those with banking experience were responsible for fighting for and winning the relative independence of the Fed after World War Two, there has been a trend towards appointing academics since Richard Nixon appointed Arthur Burns in 1970. Since then we have seen mainly academics (Volcker, Greenspan, Bernanke) in the hot seat.
That is not to say that economists have had an outstanding record managing US monetary policy, but their independence from the White House is well-established. For example, Paul Volcker ramped up interest rates in the late 1970s to contain inflation, which did not help President Carter’s plans to get re-elected in 1980. Then there is the question of the Fed’s role in the 1990 savings and loan crisis or the debt-related origins of the 2008 financial crisis, neither of them helping the US government.
Forex traders will need to consider the cultural implications of some BIG changes at the Fed next year. Academics, after all, can still be surprisingly political – indeed, to become a senior academic in the first place requires more than just intellectual capacity.
“We are not worried about the Fed losing its independence, as that bridge has already been crossed during the era of economists, at least depending on which analysts you read,” says Putnam. “A business-oriented Fed may have its biases, but it is likely to work hard to defend its independence.”
However, the nature of the internal debates may fundamentally change. Academics worry about issues like what neutral monetary policy looks like and where there is an appropriate rule to determine interest rates. Those with a business background may have other priorities: for example, they may spend more time worrying about high debt levels and will therefore be slower to raise rates than academics. They will be aware that rising rates helped to spark the S&L crisis in the early 1990s, and the mortgage-related crisis in the last decade.
Putnam thinks that if such cultural changes at the Fed come about, one casualty could be the strong dollar – heavy debt loads increase the temptation to risk higher inflation rather than worry about the strength of US economic growth. Watch carefully any senior changes made at the Fed next year. You have been warned.
