The Federal Reserve has a big meeting on tap next week, one that will be held under the cloud of an ethical dilemma and will be run by a policymaking committee that finds itself with fairly pronounced divisions about the path ahead.
Markets expect that the Fed will not make major decisions during the session. Instead, they will only give the first significant indications that the pandemic-era of historically low accommodation may be ending soon.
When Wednesday’s post-meeting statements are issued, “Tapering”, will be the buzzword. Individual officials will also release their predictions on future interest rate and economic growth.
All of that will be set against a backdrop of controversy: News reports in recent days indicate that Fed officials have been trading stocks and bonds that could be influenced at least indirectly by their policy decisions.
At the same time, speeches over the past several weeks indicate a schism between those who say the time is now to start tightening policy and those who’d rather wait.
The current circumstances could lead to some unusual dynamics for the usually stoic Fed.
It’s embarrassing to the Fed, I think. It had such a squeaky-clean reputation,” Greg Valliere, chief U.S. policy strategist at AGF Investments, said of the trading controversy that largely involved regional presidents Robert Kaplan of Dallas and Eric Rosengren of Boston. It won’t change our policy, but I doubt it. Assuming there are no other shoes to fall, I believe it will soon be back in my rearview mirror.
Although Valliere noted that the issue would fuel Fed critics like Sen. Elizabeth Warren (D-Mass.), who has been vocal in her opposition to the Fed’s looser regulation approach over the past years following the 2008-09 financial crises, the matter will not be forgotten.
A matter of credibility
More than that, though, the Fed lives on its credibility, and some of the recent problems could dent that.
There’s the market credibility issue – Wall Street and investors need to believe that the Fed is at least mostly unified in its monetary policy approach to setting interest rates and associated moves that have market impact. Then there’s the public credibility – at a time when faith in Washington’s institutions has plunged, ethical missteps only add to that and can have repercussions, especially at such a delicate time.
The ethics of this administration are poor. They ought to have known better,” Joseph LaVorgna (chief economist for Americas at Natixis, and former chief economic economist of the National Economic Council under the Trump administration) said. It’s dangerous to lose your moral authority.
Rosengren, Kaplan, and all other Fed officials that traded stock didn’t break any laws. In fact, that’s become part of the criticism leveled in some circles – that following the financial crisis the Fed didn’t do a housecleaning when it came to internal rules to make sure it avoided the kinds of conflicts that came to light during the crisis.
“Keep in mind, they already have [trading] rules they imposed on banks, for example, and yet the Fed’s governors don’t live by those same rules,” said Christopher Whalen, a Fed veteran and now chairman of Whalen Global Advisors. “After Dodd-Frank [the post-crisis banking reforms], every agency in Washington tightened up little conflicts like insider trading. But the Fed somehow is exempt from such rules? It’s absurd!
They are ridiculous.”
Still, a spokesman for the central bank said Thursday that Chairman Jerome Powell has directed Fed staff “to take a fresh and comprehensive look at the ethics rules around permissible financial holdings and activities by senior Fed officials.”
The review will aid in the identification of ways to strengthen those standards and rules. “The Board will make any necessary changes. Any changes to the Reserve Bank Code of Conduct will be included,” said the official.
The Fed is facing a complex set of circumstances, and this controversy has come against it.
The central bank is preparing to take its first steps to normalize policy again, after slashing benchmark interest rates to zero and doubling the size of its balance sheet through more than $4 trillion in bond purchases.
According to Goldman Sachs, 6 Fed officials have publicly spoken out on tapering asset purchases. Six are in favor. On inflationPowell stated that price pressures should ease quickly, but at least six Fed officials including Governor Christopher Waller have indicated they believe inflation will remain high above the central banks’ 2% goal beyond 2021.
One more complication thrown into the mix is that Powell’s term is set to expire in February, and President Joe Biden is expected to announce soon his preferred choice to lead the bank ahead. Wall Street believes Powell will be nominated once again. However, it is becoming more likely that Governor Lael Brainard will replace Randal Quarles in the role of vice chairman for supervision. He would probably have a greater hand in bank regulation.
Powell must ensure that the Fed is following sound policy and removing some of the disagreements of recent months amid all these pressures.
LaVorgna said, “It’s no fait accompli that Jerome Powell was reappointed.” The administration will wait to see what happens with the Fed’s taper, and how markets react. It could decide whether he gets reappointed.
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