The Federal Reserve's "smooth transition" from Janet Yellen to Jay Powell is set for a major speedbump.
Just two short days after Donald Trump confirmed what weekly trial balloons had reported for weeks, namely that Janet Yellen is being replaced with most "dovish" alternative possible in the face of former Carlyle partner and 5 year Fed governor Jerome Powell, the person who according to some is even more instrumental to Fed policy than Janet Yellen, NY Fed president Bill Dudley is reportedly leaving.
Late on Saturday evening, CNBC's Steve Liesman reported that Fed vice chairman Bill Dudley, a former Goldman managing director and chief economist, not to mention a key figure in "the unprecedented government response to the financial crisis", is set to join Janet Yellen among the ranks of the unemployed (if only until he hits the speaking circuit and writes a book explaining that the Fed is the cause of the world's problems) and announce his retirement as soon as next week.
Dudley, who has has headed the bank since 2009, will likely retire sometime in the spring or summer of 2018 when his replacement is found and approved, sources told CNBC. His term ends in January 2019. A search committee has already been formed.
According to Liesman, Dudley told several colleagues he was planning to leave in 2018, "and his departure is said not to be related to the decision last week by President Donald Trump to name Fed Governor Jerome Powell as the next Fed Chairman." Which probably means that Dudley's departure is precisely that: a protest against Trump's removal of Yellen with whom Dudley had a pristine relationship.
Dudley, set to turn 65 next year, became NY Fed president in the immediate aftermath of the Great Financial Crisis and was instrumental in devising the Fed's ZIRP and QE policies.
As president of the New York Fed, Dudley holds a special spot among the dozen regional bank presidents. The incumbent always serves as vice chairman of the rate-setting Federal Open Market Committee (FOMC) and always votes at policy meetings, while other regional presidents have a rotating vote. More importantly, before he became NY Fed president, Dudley headed the New York Fed's markets group - also known elsewhere as "the plunge protection team" - which Liesman describes as "a critical job that oversees the trades and market operations required to set the Federal Funds Rate." Liesman is right.
In both positions, Dudley was a principal player in Fed decisions concerning the demise of Lehman Brothers, AIG and Bear Stearns, along with emergency measures taken by the central bank to stanch a meltdown in the financial system.
Dudley's "list of accomplishments" is long: several trillion dollars long in fact. Under the former Goldman executive, the NY Fed was responsible for accumulating the trillions in assets the Fed purchased under QE, bringing its balance sheet up to $4.5 trillion. It is now responsible for the market operations underway to reduce the balance sheet.
Dudley's departure comes at a time of dramatic change at the Fed. in addition to a new Fed Chairman, Vice Chairman Stan Fischer left his post in October, and there are currently three open seats on the seven-member Board of Governors. That number may rise to four if Yellen leaves the board when Powell is confirmed, and before others are nominated and confirmed by the Senate.
The choice of Dudley's replacement will be made by the New York Fed's Board of Directors and approved by the Federal Reserve Board. Dudley is expected to speak at the economic club of new York at noon on monday.
With Dudley's departure, the Fed will lose one of its more prominent centrists as the following Dove-Hawk ranking from Barclays shows.
As for new Fed chair Jay Powell, while many already had a low opinion of him being able to keep the system together once the next crash happens, the departure of a key Fed veteran such as Bill Dudley will only make it that much more complicated to preserve stability in the not too distant future. Here are some scathing thoughts from Capital Economics on Powell's tenure as next Fed chair:
Powell an underwhelming choice to be Fed Chair
- Some are born great, some achieve greatness and some have greatness thrust upon them. Jerome Powell belongs in the third category. President Donald Trump’s nomination of Powell to be the next Fed Chair is an underwhelming choice. The Fed will face many difficult challenges over the next few years and it is unclear whether Powell has the skills to navigate them.
- The polite thing to do would be to offer some platitudes about Powell being the ‘safe’ choice, who will provide continuity with the Yellen-led Fed’s monetary policy approach of gradually normalising interest rates and might be more inclined to loosen financial regulation. That said, although Powell is more open to deregulation than Yellen, he is hardly a free market zealot. He has expressed support for simplifying and “recalibrating” regulation, particularly the Volcker rule but, at the same time, he has warned that “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”. At least financial markets will be comforted that Trump didn’t pick the potentially much more hawkish John Taylor or Kevin Warsh.
- Nevertheless, Powell’s resume is not up to the standards we would expect of a nominee for Fed Chair. For a start, unlike the last three Fed Chairs, he is a lawyer rather than an academically trained economist. His other experience is in investment banking and private equity. He also spent some time at the Bipartisan Policy Center and worked in the Treasury for a couple of years during the Bush Snr administration. None of those roles marked him out to be the next leader of the world’s most important central bank.
- Powell was only nominated to join the Fed’s Board of Governors in 2011 because then-President Barack Obama needed a token Republican to ease the accompanying nomination of Jeremy Stein through the Republican-controlled Senate. Since joining the Board, Powell has had little to say of any interest. His speeches have focused on regulatory issues and when he has spoken about monetary policy issues, he has been careful never to deviate from the in-house view. Not surprisingly, markets initially didn’t see Powell as a possible candidate to be Fed Chair.
- Admittedly, we could be wrong about Powell. He is still something of an enigma and he may emerge as a strong leader with a firm grasp of monetary and economic issues. His Senate nomination hearing in the coming months will provide the first insight into what type of Fed Chair he will be. Regardless of his performance at the hearing, however, we expect him to be confirmed without too much drama.
- There is an argument to be made that Powell’s market experience could prove to be crucial in the coming years. But there are potentially even bigger challenges ahead. As an institution, the Fed is grappling with the most fundamental question of what drives inflation in the modern US economy, as it seeks to explain why it has been unable to hit its 2% inflation target consistently. Should the Fed stick with the orthodox Phillips curve view that shrinking slack in the labour market and wider economy will eventually generate an acceleration in wage and price growth or abandon that framework? If the Fed does abandon it, what becomes the working model of inflation? Inflation expectations? Does inflation targeting even make any sense in a world where interest rates influence domestic activity and employment, but activity and employment don’t influence prices? Monetary targeting was abandoned because the old relationships with prices broke down. Inflation targeting isn’t sacrosanct. We would feel more comfortable if it was the academically outstanding economist Janet Yellen who was leading that research, particularly when she had the benefit of the strong intellect and experience of Vice Chair Stanley Fischer at her side.
- Powell’s nomination means that we still expect the Fed to raise interest rates once more this year and then four times next year. That is slightly more hawkish than the FOMC’s own projections imply, but those forecasts don’t appear to factor in a fiscal stimulus. Beyond that, a lot still depends on who Trump picks to fill the other vacancies on the Fed’s Board. With Powell’s promotion, there will be four vacancies, including the Vice Chair position. Otherwise, the risk of a serious policy mistake – in either direction – will arguably be higher under Powell’s leadership than under Yellen’s. And policy communications may become more muddled, if Powell doesn’t provide strong intellectual leadership and the policy debate descends into a free-for-all among regional Fed Presidents.