After an adventurous six-month period from December to June, when the Federal Reserve raised interest rates three separate times, the U.S. central bank has shifted into neutral in the second half of 2017. In essence, the stubbornly low rate of inflation, combined with a lack of fiscal support and a series of natural disasters, has prompted Fed voters to tap the brakes on interest rate normalization. Another factor playing a role in the Fed’s inaction is the potentially lame duck status of the central bank’s core leaders.
By far the biggest cloud of uncertainty hangs over the position of next Chair of the Fed. Janet Yellen’s term as Fed chair comes to an end in early February, and based on her recent comments, the odds of President Trump reappointing her are fading.
Many market participants were disappointed in Yellen’s lack of meaningful commentary on the economy and market policy in August’s Jackson Hole Symposium speech. What she didn’t say (i.e., not implying that the Fed was likely to raise interest rates again this year) definitely had a meaningful short-term impact on the dollar, but it’s the topics she did discuss that may end up having longer-term implications.
In her speech, Yellen laid out a passionate defense of the benefits of increased financial regulation in the wake of the Great Financial Crisis, putting her firmly at odds with President Trump, who’s made rolling back regulations a centerpiece of his presidency. Yellen noted that additional regulations had had no “readily apparent” adverse effects on the economy and that “any adjustments to the regulatory framework should be modest.” Yellen’s non-conciliatory approach toward the U.S. President’s agenda makes it less likely that Trump will reappoint her to head the central bank when her term expires.
Like most sitting politicians, Trump has expressed a clear desire for low interest rates from the U.S. central bank. In that vein, former bank executives including Gary Cohn from Goldman Sachs, Richard Davis from U.S. Bancorp, and John Allison from BB&T have been rumored as potential candidates. In all likelihood, these financial titans would mirror many of Yellen’s characteristics; specifically, they all appear to be pragmatic consensus-builders with slight dovish leans when it comes to policy.
Where Cohn and company would differ dramatically from Yellen would be in their outlook toward regulation. As dyed-in-the-wool bankers, they would likely advocate for easing financial regulations on small lenders and scaling back the Fed’s annual stress tests. Even if Trump opts for a more traditional appointee like former Fed Governor Kevin Warsh or Columbia University economist Glenn Hubbard, a bias toward deregulation is likely.
Beyond Yellen’s predicament, Stanley Fischer, the august Vice Chair of the central bank, recently announced his resignation effective in mid-October, a full eight months before the official end of his term. It’s also worth noting that there are three other open seats on the seven-member Federal Reserve Board, giving Trump and company plenty of latitude to form the central bank around his vision (assuming he has one and Congress cooperates by approving his nominees).
So what would a dovish, deregulation-focused central bank mean for the greenback? As we’ve seen so far this year, the Fed’s caution about raising interest rates has crushed the dollar, especially with other global central banks moving toward tightening policy (see “Dollar daze,” left). On the other hand, decreasing regulation can have a stimulatory impact on economic growth, at least in the short term. At a minimum, it’s hard to imagine the next Fed Chair being any more cautious than Yellen has been to date, even if Yellen herself is able to defy the odds and get reappointed to another term.
Moving forward, FX traders should keep a close eye on the Trump administration’s comments regarding the central bank. After all, the temperament and philosophies of the men and women in charge of managing the economy will have a far greater impact on the value of the dollar than any individual economic report. With traders’ expectations for any more tightening from the Fed this year already in the dumps, a change at the top of the U.S. central bank could be just what dollar bulls ordered.