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President Biden’s reappointment of Fed Chairman Powell and promotion of Governor Brainard to Vice Chair for Monetary Policy was incrementally positive for Fed independence and reduces the probability of a Fed credibility crisis. As we wrote in Saturday’s note, another politically motivated Fed Chair appointment following President Trump’s replacement of Chair Yellen with Powell, risked a repeat of the Nixon/Arthur Burns ‘70s scenario that was a major factor in the Great Inflation. That said, market participants still believe the Fed needs to accelerate the pace of reduction of asset purchases as evidenced by a sharp rally in front-end TIPS yields (real rates) and move higher in Fed policy rate expectations. In other words, the Fed’s optionality assertion needs to be exercised at the December FOMC meeting. Wednesday’s November FOMC minutes may offer insights as to whether the optionality assertion was merely a concession to the handful of FOMC participant hawks or an actual shift from the measured removal of policy accommodation 2004-2006 innovation that has been characteristic of policy normalization since.
The immediate reaction was favorable, equity reflation sectors rallied despite a sharp move higher in front-end real rates. The dollar rallied against other major currencies, bitcoin and gold, but was flat against emerging market currencies. This combination speaks to market participants views on Fed credibility. There are additional appointments to come as well as two regional bank presidencies. The trajectory of bank regulatory policy remains likely to tighten, the vice chair of supervision remains open and there will be considerable pressure from Senators Warren and Brown to appoint a regulatory hawk particularly if the Omarova OCC nomination collapses. Questions about a Fed payments system, a central bank digital currency (CBDC), a Fed deposit system and other intrusions of the central bank into the private sector are far from resolved. Additionally, when analyzing the outlook for monetary policy, the differences between Powell and Brainard’s views are less important than Clarida and Brainard. We wrote earlier this year that Governor Brainard was the third person in the leadership rather than NY Fed President Williams, given Powell’s lack of monetary policy credentials, Brainard becomes even more influential in monetary matters with Clarida’s departure. The Fed will be under pressure through the cycle to facilitate the growing federal debt. The ‘60s analog when the Fed was ‘independent within, not of the government’ and the dual mandate bias shifted from inflation to employment is intact, though it does not appear we will not skip straight to the ‘70s. This is good news for the reflation bias of our tactical portfolio, but the Fed remains on a path towards less credibility in 2022.
Barry C. Knapp
Managing Partner
Director of Research
Ironsides Macroeconomics LLC
908-821-7584
bcknapp@ironsidesmacro.com
https://www.linkedin.com/in/barry-c-knapp/
@barryknapp
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