(Bloomberg Opinion) -- The Federal Reserve on Wednesday will make what is probably its biggest monetary policy decision under Jerome Powell, who took over as head of the central bank in February 2018. The Fed must decide whether to signal that it’s leaning toward easing soon or that it will remain “patient” and hold interest rates steady into the foreseeable future. Former Fed Vice Chairman Stanley Fischer just complicated this decision after Bloomberg News reported this over the weekend:
Fischer also said there was a good chance the Fed wouldn’t have raised borrowing costs in December if Trump had been less vocal, adding: “It’s not a desirable thing to have the president pronouncing on monetary policy.”
Wow! Fischer just suggested the Powell Fed made a purely political decision in December, possibly in violation of its dual mandate to promote full employment and stable prices. If this is true, it means the Fed does not act independent of politics. If so, then it should be subjected to political pressure.
Fischer was not in the room six months ago when the decision was made to hike rates; he was just offering his very well informed opinion as the “dean of central bankers.” Fischer knows how to choose his words carefully. He was vice chairman of the Fed from 2014 to 2017. He headed the Central Bank of Israel from 2005 to 2013, guiding it through the financial crisis. He was the doctorate thesis advisor to former Fed Chairman Ben S. Bernanke, current European Central Bank President Mario Draghi, Harvard economist Greg Mankiw, former International Monetary Fund chief economist Oliver Blanchard as well as scores of other prominent economists.
Fischer’s words on Sunday could not have been timed worse for the Fed. Given this credible voice suggesting that the Fed might have acted to “get” President Donald Trump, who has criticized the central bank, when it hiked rates in December, any decision this week perceived to be not dovish enough for markets supports further criticism that policy makers are again acting political and not in the best interest of the economy.
Adding to the Fed’s headache is a report Tuesday that the White House in February was looking for a legal way to demote Powell to a Governor. National Economic Advisor Larry Kudlow said the White House is no longer considering this option. No doubt that Trump believes the Fed is as political as Fischer suggested and is trying to treat it as such.
The markets have been pricing in multiple Fed rate reductions for weeks and are expecting the Fed this week to set up a July cut by dropping the word “patient” from its statement. They also expect the central bank’s updated “dot plot” of future rates to show that some policy makers now expect a cut this year, after none did in the March update.
The problem is the Fed has been reluctant to embrace this view, as Federal Reserve Bank of Chicago President Charlie Evans said two weeks ago:
At face value, it would suggest that the market sees something that I haven’t yet seen in the national data.
But as noted in my Bloomberg Opinion column on May 21, markets are diverging from the Fed on the outlook for inflation. Market measures are pointing to low rates of expected inflation for an extended period, a situation that Powell has called “transitory.” But on Friday the University of Michigan’s survey of inflation expected over the next five to 10 years made a new all-time low. This is a favorite measure of current Fed vice chair Richard Clarida.
There is an old saying in markets that the Fed decides when to raise rates and the market decides when to cut rates. That is what is happening now.
The Fed could elect to view the market as another important data point and lean toward cutting. But if it decides to push back against an ease, the markets could very well react badly. Trump will no doubt attack the Fed in that situation, but he would have a credible voice in his corner with Fischer suggesting the central bank acted politically in December to hike rates.
What should the Fed do? It should have been listen to markets all along and backed off the hiking and now move toward an easing. But this is not how this Fed conducts policy, and now thanks to Fischer, Trump can accuse the central bank of damaging the economy just to get back at him. This is not helping the Fed to maintain its independence.
