On Thursday afternoon, around 3pm, Donald Trump will officially nominate Jerome Powell to be the next Chair of the Federal Reserve, replacing Janet Yellen when her term is up on February 1st. According to virtually every financial analyst, the former Carlyle Partner, Jay Powell, represents "continuity" on the Federal Reserve and would conduct monetary policy in a similar fashion as Yellen. As a result, Powell will proceed with the current balance sheet normalization schedule and continue to guide markets toward the "dots". He is also expected to put a greater priority on scaling back financial market regulation, working with Randy Quarles who is the newly appointed Vice Chair for Supervision.
While we presented key recent soundbites from Powell speeches yesterday, here is some more background:
Jerome Powell is a trained lawyer and not an economist. Powell has been a Fed Governor since 2012 and was involved in the decision-making behind QE3 and then policy normalization in recent years. Prior to joining the Board, he was a visiting scholar at the Bipartisan Policy Center, a partner at the Carlyle Group, and worked at the Treasury under the GWH Bush administration.
Powell is a Republican who built a vast wealth as a partner at Carlyle. Powell's latest financial disclosure from June lists his net worth between $19.7 million and $55 million. If he gets the job, Powell would be the richest Fed chair since banker Marriner Eccles, who held the position from 1934 to 1948, according to the Washington Post.
Powell has established a reputation as a centrist on the monetary policy spectrum, aligning his views with that of the consensus. In fact, in speeches he often references how the committee thinks (good practice for post-FOMC press conferences).
How could regulation change under the banker-friendly Powell?
As to BofA, in a recent speech in June, Powell discussed five possible regulatory reforms. He noted that the "objective should be to set capital and other prudential requirements for large banking firms at a level that protects financial stability and maximizes long-term, through-the-cycle credit availability and economic growth. To accomplish that goal, it is essential that we protect the core elements of these reforms for our most systemic firms in capital and liquidity, stress testing and resolution." His five main points:
- Simplification of regulation of small and medium-sized banks
- Resolution plans: consider extending the cycle for living will submissions from annual to once every two years while focusing every other of these filings on key topics of interest
- Reassessing the Volcker Rule: possibility of eliminating or relaxing aspects of the implementing regulation in ways that do not undermine the Volcker rule's goals
- CCAR: enhance transparency
- Supplementary leverage ratio: examine the relative calibrations of the leverage ratio and the risk-based capital requirements
And going back to Bank of America, in a note from its chief economist out this morning, Michelle Meyer writes that there are two important questions that the new Fed leadership will have to address in short order:
- What is the ultimate size of the Fed's balance sheet and should we continue to rely on administered rates?
- What is the long-run equilibrium rate (R*)?
On the question of the balance sheet, the current Fed - under the guidance of NY Fed President Dudley - seem to be leaning toward shrinking the balance sheet by roughly $1.5tr and maintaining a floor system for reserves. This implies keeping the administered rates of IOER (interest on excess reserves) and ON RRP (overnight reverse repo) in the future. Powell seems to be in agreement stating in June of this year that "To affect financial conditions, the Federal Reserve has therefore used administered rates, including the interest rate paid on excess reserves (IOER) and, more recently, the offering rate of the overnight reverse repurchase agreement (ON RRP) facility. This approach, sometimes referred to as a "floor system," is simple to operate and has provided good control over the federal funds rate. In November 2016, when the Committee discussed using a floor system as part of its longer-run framework, I was among those who saw such an approach as "likely to be relatively simple and efficient to administer, relatively straightforward to communicate, and effective in enabling interest rate control across a wide range of circumstances."
There has long been a debate over the right assumption for long-term rates and therefore the terminal rate in this hiking cycle. The markets have been convinced for some time that the terminal rate in this cycle will be considerably below prior hiking cycles. The current Fed consensus has also marked down estimates with the most recent forecast of 2.75% for long-run interest rates. This has gone hand-in-hand with a downgrade to estimates of potential GDP growth to 1.8%. However, if tax reform passes and progress is made on financial deregulation, the view of higher structural rates could become a possibility. This would change the narrative from the Federal Reserve and could allow leadership at the Fed to talk about a faster hiking cycle given a higher terminal rate. However, in the meantime, we expect a Powell-led Fed to stick with the current narrative of structurally lower growth and interest rates.