As much as the Federal Reserve would prefer to avoid it, it appears that the U.S. central bank will be drawn into one of the most divided election campaigns in U.S. history.
Two news stories appeared on Friday in separate publications suggesting that both presidential candidates would want to pressure, or at least encourage, the Fed to lower its key policy interest rates. That they both were published just ahead of the Federal Open Market Committee meeting on April 30-May 1, at which Fed officials are almost certain to maintain their higher-for-longer policy stance, seems curious at the least.
The Wall Street Journal reported that former President Donald Trump’s allies were drafting proposals to limit the Fed’s independence. During his term, Trump often castigated Fed Chair Jerome Powell for keeping interest rates too high, which marked a break from the norm of recent administrations to respect the independence of the Fed.
reported some Democratic strategists saying that President Joe Biden should follow his predecessor’s example and pressure the Fed to reduce high borrowing costs, which they see hurting his chances of re-election.
Thus far, Biden has commented only that he still expects lower rates later this year. And given Treasury Secretary Janet Yellen’s previous position as Fed chair, there is probably institutional reluctance for this administration to pressure the central bank further.
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The White House’s direct power over the Fed is limited to nominating members of the Fed’s Board of Governors, including the chair, similar to nominating Supreme Court justices. The central bank was created by an act of Congress, which can change it through the legislative process.
But the executive branch can influence monetary policy via the dollar’s exchange rate, which is under the aegis of the Treasury. Trump could force intervention to cheapen the greenback, says Joseph Carson, former chief economist at AllianceBernstein. Politico recently reported that advisers to the former president are discussing ways to lower the dollar’s value in addition to tariffs to reduce the U.S. trade deficit.
Such a cheap-dollar gambit could backfire in two ways. First, a cheaper dollar raises the cost of imports, which feeds into inflation. It also could lead to higher, not lower, interest rates, as global capital needed to finance the huge U.S. budget and current-account deficits would be deterred by a dollar-debasement policy. And it would further erode the greenback’s status as the world’s main reserve and transaction currency.
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No doubt, questions about Fed independence will come up at Powell’s post-FOMC news conference, not least because little if any news is likely to be made by the panel’s decision to hold rates unchanged. He will surely parry any queries with the usual assurances that politics plays no part in the Fed’s deliberations. The policy statement is apt to be cut and pasted with a few tweaks from the March 20 version. One possible addition suggested by NatWest Fed watchers is to acknowledge that “recent progress has stalled” in reducing inflation.
One question that might be asked of Powell is whether his view, first voiced last December, that the federal-funds rate had peaked for this cycle remains operative. Inflation hasn’t receded as expected. But, as Vincent Reinhart, chief economist at Mellon, observes in an interview, the last thing Fed officials ever want to do is reverse themselves.
Indeed, the Fed’s favored inflation gauge has regressed in recent months. The core personal consumption expenditures index, which excludes food and energy costs, increased 0.3% in March, as expected. While the year-over-year rate is running at 2.8%, core PCE rose at a 4.5% annual rate over the most recent three months, according to Michael Lewis, head of the Free Market advisory. More PCE reports like this and rate hikes will be on the table, he writes.
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Higher prices and other factors also made the initial estimate of first-quarter gross domestic product look rather lackluster. Real GDP growth slowed to a 1.6% annual rate from the fourth quarter’s 3.4% pace. But excluding government spending (which slowed sharply in the quarter), inventory swings, and exports (influenced by foreign demand), you’re left with consumption plus business fixed investment and residential investment.
This measure, called real final sales to private domestic producers, is the best underlying measure of what the Fed is trying to influence, argue John Ryding and Conrad DeQuadros, economic advisors to Brean Capital.
In real, inflation-adjusted terms, this metric grew at an annual rate of 3.1% in the first quarter, following advances of 3.3% and 3.0% in the two preceding quarters. Measured in current dollars, this metric has grown at a 5.6% nominal annual rate over the past three quarters and 6.1% in the latest quarter. “This simply cannot be seen as soft,” they write in a client note.
Powell & Co. thus confront conflicting pressures at this coming week’s FOMC meeting. Politicians on both sides would favor lower rates (although tilting policy in favor of the incumbent ahead of the election would rightly bring howls from the challenger). But with inflation still well above the Fed’s 2% target and the economy growing steadily, with unemployment below 4%, the rationale for rate cuts is weak. Under other circumstances, rate hikes might be on the table.
Write to Randall W. Forsyth at randall.forsyth@barrons.com