The media has been focusing on how unprecedented President Trump’s outspoken criticism of Federal Reserve policy is. But then a lot of what Trump does marks a departure from his predecessors.
Yet he persists. On Monday, the day before the Fed’s policy meeting was to begin, he tweeted:
“It is incredible that with a very strong dollar and virtually no inflation, the outside world blowing up around us, Paris is burning and China way down, the Fed is even considering yet another interest rate hike.”
Last week, he said the Fed is foolish to keep raising rates when the economy is clearly swooning and inflation is at bay.
This loud and constant criticism puts the Fed in an awkward, equally unprecedented position. It cannot now forgo an interest rate hike at the meeting, even if the central bank thought it best, because it would then look like Trump had bulldozed the policymakers into submission.
So the Fed, like the European Central Bank last week, must proceed with tightening measures because of the politics of central bank independence and despite economic data possibly suggesting a pause, irrespective of any previous Fed commitments.
This dilemma is partly of its own making, because the Fed has been so confident in predicting gradual rate hikes through its forward guidance. Had the Fed been following the opaque and mysterious ruminations of pre-crisis central bankers, it would not be out on this limb as a target for the president.
Fed Chairman Jerome Powell has already said forward guidance will become more tentative, but that will be hard to get people to believe. Fed policymakers have always claimed decisions were data dependent, yet they've stuck to their agenda regardless of the data. Inflation remained stubbornly low but they hiked rates as though prices were racing ahead.
So now the focus is on changes in the Fed’s agenda. Analysts expect the dot-plot graph of where the 17 Fed policymakers anticipate interest rates to be will show the pace of increases next year slowing down, from two or three to one or two.
ECB President Mario Draghi managed to pull off the trick of acknowledging a slowdown in economic momentum while expressing enough confidence in growth to go ahead with tightening, in the form of ending ECB asset purchases. Powell will have to perform a similar sleight of hand.
However, his task is more difficult because the Fed is tightening the monetary screws a little faster. Not only are they actually raising rates, they are reducing monetary accommodation by trimming their actual bond holdings at the rate of $50 billion a month.
The double whammy is too much, former Fed governor Kevin Warsh argued in a Wall Street Journal op-ed this week with Stanley Druckenmiller, especially given the timing, which is much too late in their view. At this late point in the economic cycle, one or the other would be better, they think.
Powell has said the Fed will continue reducing its bond-holdings until its balance sheet reaches about $2.5 trillion, down from its current $4.14 trillion. But analysts are now forecasting that the Fed will at least pause this tightening process at around $3.8 trillion, in mid to late 2019.
So Powell will have a tall order when he takes the podium at Wednesday’s press conference. He will have to make the interest rate hike sound plausible in spite of Trump’s criticism, acknowledge a slowing economy but expressing confidence in it, and play down forward guidance but provide new forward guidance regarding a slower pace of interest rate hikes. Whether he can also squeeze in some reassurance on quantitative tightening is doubtful, but it might help.