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Who Matters In The FOMC?
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Sensing the Fed is finally on the cusp of normalizing policy interest rate, there will be a sharper intensity in market’s Fed watching, not just about the FOMC decisions
and the minutes, and also Fed officials’ commentary.
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A recent St. Louis Fed report highlighted that between
2008 and 2014, the Fed Reserve bank presidents accounted for all of the dissents since 2008 which is unusual according to the authors. In prior years, both Fed
Presidents and Fed Board Governors dissented.
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In 2014 FOMC decisions so far, Charles Plosser and Richard Fishers are the key dissenters. And we believe that
they may be joined by Loretta Mester in the dissent
camp for the remaining FOMC decisions in 2014. But
their dissent is unlikely to have a large effect on policy,
as Fed Chair Janet Yellen will still be able to press ahead
with majority support rather than seeking unanimity
(7-3 votes in the base case scenario).
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In 2015 FOMC, Richard Fisher, Narayana Kocherlakota,
Loretta Mester, and Charles Plosser will rotate out of
their voting positions, and the incoming voters are
Chicago Fed President Charles Evans (Dove), Richmond Fed President Jeffrey Lacker (Hawk), Atlanta
Fed President, Dennis Lockhart (Centrist – tentative
dovish bias), and San Francisco Fed President, John
Williams (Dove) which we should pay more attention
to. So it seems there will be more doves replacing the
departing hawks (Fisher and Plosser) for now, which in
our view benefits Yellen’s dovish approach.
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The rest of the important 2015 FOMC voters are the 5
Fed Board Governors and the New York Fed President, William Dudley. It is unlikely for US President
Obama to fill the 2 vacant Governor seats next year, so
the number of FOMC voters is expected to remain at 10
in 2015.
Who Are The Key Players In 2014 FOMC?
In response to the onset of the 2008 financial crisis, the US
Federal Reserve started cutting its benchmark policy interest
rate, the Fed Funds Target Rate (FFTR), first on 18 Sep 2007, by
an initial 0.5% cut to 4.75%, and by the time we reached the
10th rate cut on 16 Dec 2008, it was lowered by a final 0.5%,
to between 0% and 0.25% where it has remained ever since.
And when the aggressive cuts in short interest rates proved
to be insufficient, the Fed also embarked on unconventional
quantitative easing (QE) programs as part of their expansionary monetary policy to help turnaround the ailing US economy and the sharp increase in unemployment.
After quite a few false starts (of expecting interest rate hikes
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throughout the last few years) and the QE program coming to an end in the next FOMC meeting on 28-29 Oct 2014,
the market is sensing that the Fed is finally on the cusp of
normalizing the FFTR. The market consensus is currently expecting the Fed’s rate-lift off to take place in the summer of
2015 (we are expecting it to be announced in the 16-17 June
2015 FOMC). Thus, there is increasingly intense interest in Fed
watching, both in terms of the FOMC decisions & minutes as
well as the comments from senior Fed Reserve officials that
are participants in the FOMC (voters and non-voters).
First, it is instructive to have a bit of background to the monetary policy formulation process within the US Federal Reserve. The Federal Reserve controls the three tools of monetary policy--open market operations, the discount rate, and
reserve requirements. The Board of Governors of the Federal
Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee
(FOMC) is responsible for open market operations. Using the
three tools, the Federal Reserve influences the demand for,
and supply of, balances that depository institutions hold at
Federal Reserve Banks and in this way alters the federal funds
rate. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to
other depository institutions overnight.
The FOMC which consists of 12 members--the seven members of the Board of Governors of the Federal Reserve
System; the president of the Federal Reserve Bank of New
York (permanent seat); and four of the remaining eleven
Reserve Bank presidents, who serve one-year terms on a
rotating basis. Non-voting Reserve Bank presidents attend
the meetings of the Committee, participate in the discussions, and contribute to the Committee’s assessment of the
economy and policy options. (Information taken from
http://www.federalreserve.gov/monetarypolicy/fomc.htm)
Currently, there are 2 vacant governor seats which are unlikely to be fill anytime soon as there is not much Senate session
days left before the mid-term elections on 4 November 2014,
and the Senate has taken an average of 119 days to confirm
Obama’s 10 Fed Board nominations since 2009. So there are
only 10 voting members in the 2014 FOMC comprising of:
1. Fed Board of Governors, Chair Janet Yellen
2. Fed Board of Governor, Vice Chairman Stanley Fischer
(permanent FOMC voter)
3. Fed Board Governor Jerome Powell
(permanent FOMC voter)
4. Fed Board Governor Lael Brainard
(permanent FOMC voter)
5. Fed Board Governor Daniel Tarullo
(permanent FOMC voter)
6. New York Fed president and Vice Chairman, William Dudley
(permanent FOMC voter)
US FEDERAL RESERVE IN FOCUS
7. Dallas Fed President Richard Fisher
(voter in 2014 FOMC)
8. Minneapolis Fed President, Narayana Kocherlakota
(voter in 2014 FOMC)
9. Cleveland Fed President Loretta Mester
(voter in 2014 FOMC)
10. Philadelphia Fed President Charles Plosser
(voter in 2014 FOMC)
An Interesting History Of FOMC Voting & Dissent
In a recent report published in the 3Q 2014 Federal Reserve
Bank of St. Louis Review (16 Sep 2014), the authors, Daniel
Thornton and David Wheelock, found that over the period
1957-2013, Fed Reserve bank presidents dissented 241 times,
and Fed Governors dissented 208 times. While the number of
dissents by governors surpassed the number of dissents by
presidents in many years, Thornton and Wheelock noted that
presidents have accounted for all but four (72 of 76) dissents
between 1994 and 2013. If the period is narrowed down to
between 2008 and 2014, then the Fed Reserve bank presidents accounted for all of the dissents since 2008 which is
unusual according to the authors. The report also found that
“over the FOMC’s history, Fed Reserve Bank presidents more
often dissented in favor of tighter policy than easier policy,
whereas a majority of dissents by Federal Reserve governors
were in favor of easier policy.” But the report also noted that
not all dissents were for or against the current policy stance
but the voter “dissented because he or she disagreed with
language in the Committee’s statement about possible future
changes in policy.”
Of course history cannot serve as an accurate guide to
how the current FOMC members will vote and we do have
two new FOMC board Governors (Stanley Fischer and Lael
Brainard, confirmed by Senate in June 2014) and a new Fed
President (Loretta Mester who succeeded Sandra Pianalto as
Cleveland Fed President with effect from 1 June 2014).
So far in 2014, we have went through 6 FOMC and three were
passed with unanimous decisions (January, April and June)
while the other three were passed with dissenters.
In March 2014 FOMC, Narayana Kocherlakota dissented
due to the language used in the statement and not against
the policy stance. However, in the July 2014 FOMC, Charles
Plosser dissented as he objected to the Fed’s guidance of
keeping short-term interest rates near zero for a “considerable time” after its bond-buying program ends. In the September 2014 FOMC, Charles Plosser dissented for the second
straight meeting with the same objection and he was joined
by Richard Fisher who dissented on similar grounds as he “believed that the continued strengthening of the real economy,
improved outlook for labor utilization and for general price
stability, and continued signs of financial market excess, will
likely warrant an earlier reduction in monetary accommoda-
tion than is suggested by the Committee’s stated forward
guidance.”
Will There Be More Dissents In 2014?
If the US remains on its current course of continued, moderate
improvement (both in the economy and the labor market),
then both Plosser and Fisher will likely continue to dissent
in the Oct 2014 and Dec 2014 FOMC meetings. And we note
that both Plosser and Fisher will be rotated out of their voting
roles in the 2015 FOMC, so they probably have to make their
voices heard louder (via their dissent votes) in the last 2 FOMC
decisions of 2014. The question is whether anyone else will
be joining them in voting against policy decision.
We note that the recently appointed Cleveland Fed President, Loretta Mester, began her career in the Federal Reserve
Bank of Philadelphia where she rose to the position director
of research at the Federal Reserve Bank of Philadelphia and
chief policy advisor prior to her current appointment. Since
Mester retained her role under the hawkish Philadelphia Fed
president Plosser, the initial expectations were that her views
would likely align with his. That said, she has voted for the
FOMC monetary policy action in the last 3 FOMC decisions,
unlike her former boss. Her recent comments (5 Sep 2014)
noted that while the “exact timing” of rate hikes depends on
the economy, Mester opined that the Fed is much closer to
achieving its economic goals than it has been for a long time,
as the economy is on firmer ground. She also wants the Fed
to make clearer that the timing and pace of future interest
rate hikes will be driven by the performance of the economy
although she declined to say when she thinks the lift-off will
be.
In comparison, Minneapolis Fed President, Narayana Kocherlakota’s latest comments (22 Sep 2014) warned against raising
interest rates with inflation so low and opined the unemployment rate overestimates labor market recovery. Instead, he
advocates that the Fed to set the goal to bring inflation to 2%
to avoid “European and Japanese” situations and proposed
the Fed set a 2-year time horizon to achieve its 2% inflation
target. This puts him clearly in the dovish camp, as opposed
to Plosser and Fisher.
As for the New York Fed President and Vice Chairman, William
Dudley (permanent voter in FOMC), his recent comments (22
Sep 2014) noted that he would be “very happy” to be able
to raise rates some time in 2015 if conditions warrant. But
he also stressed that it was important to practice patience
rather than risk a premature rate hike “just for the sake of raising them.” He also commented it is not yet clear how large
or small the central bank’s balance sheet should be in the
long term. And in unusually direct remarks about the US currency from the central bank, Dudley said “If the dollar were
to strengthen a lot, it would have consequences for growth.”
Thus, our read is that Dudley is still and will remain on Yellen’s
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US FEDERAL RESERVE IN FOCUS
side in the dovish camp.
Thus if we were to pick another FOMC voter likely joining the
dissent camp in October and December, we think Mester is
most likely given her recent opinions and her long working
relationship with Plosser, and that certainly increase some
pressure on the doves within voting FOMC members. We
assume that the Fed Board Governors, Dudley & Kocherlakota will remain supportive of Yellen, so even if we get
one more dissent, the margin will still be a comfortable
7-3 in her favor, and she will still be able to press ahead
with majority support rather than seeking a unanimous
agreement.
Looking Into 2015 FOMC
Going into next year, the composition of the 2015 FOMC will
change. The 5 current Fed Board Governors will remain as
will the New York Fed President and Vice Chairman, William Dudley who has a permanent vote in FOMC. There
remain 2 vacancies on the Fed Board of Governors which we
think US President Obama will have a difficult nominating
and for the US Senate to confirm their appointments in 2015
because of 1) the uncertain outcome for the 4 November
2014 mid-term elections which could shift the power balance
from Democrats to Republicans in the Senate in 2015, and 2)
it is likely to be another politically difficult year for Obama in
2015 as the debt ceiling negotiations will likely re-surface to
haunt us again in the odd-numbered years where there are
no US presidential and Congressional elections.
As for the four Reserve Bank Presidents, Richard Fisher, Narayana Kocherlakota, Loretta Mester, and Charles Plosser will
rotate out of their voting positions in 2015 FOMC but will remain as non-voting Reserve Bank presidents attending the
meetings of the FOMC. Replacing them as voters in the 2015
FOMC will be:
1. Chicago Fed President, Charles Evans (Dove)
2. Richmond Fed President, Jeffrey Lacker (Hawk)
3. Atlanta Fed President, Dennis Lockhart (Centrist – tentative dovish bias)
4. San Francisco Fed President, John Williams (Dove)
And these will be the ones we will be watching them
closely in addition to the other six permanent voters on
the FOMC. As far as we can tell for now, Evans and Williams
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are likely to be in the Dove camp (Evans acknowledged the
significant improvements in the labor market but thinks inflation is nowhere near target and it remains appropriate to
keep rates low till well into 2015 [July 2014] while Williams
still believes there is significant slack in labor market while
he is not concerned about inflation at all, and rate hikes are
not likely to happen till middle of 2015. And even if rates are
hiked, the process is likely to be very gradual so as not to upset the markets [22 Aug 2014]).
And while Lockhart is widely considered to be a centrist, we
viewed him as having a dovish bias based on his latest comments (He expected changes to the Fed policy statement in
upcoming meetings and he said the Fed is still focused on a
mid-2015 rate lift-off. He is not worried about inflation and
he is one “who prefers we let a little more time pass in order
to have the evidence accumulate that we are on a solid track
and we are likely to stay on that track.” [23 Aug 2014]) Lacker
is probably the sole hawk within the incoming Reserve Bank
Presidents (In early August, Lacker warned that the market
may be underestimating the pace of Fed Reserve rate tightening cycle over the next two years. And in the September
FOMC, Lacker identified himself as the lone dissenter on the
Fed Reserve’s updated exit strategy plan and explained his
opposition is due to the Fed’s plan to keep holding mortgage-backed securities in their updated exit strategy. Lacker
also previously opposed to Fed’s buying of MBS as he felt it
gives an advantage to that sector of borrowings over other
types of borrowings by consumers).
So it seems that in 2015, there will be more doves replacing the departing hawks (Fisher and Plosser) for now,
which in our view benefits Yellen’s dovish approach to deliver forward guidance for the eventual rates lift-off at a more
gradual trajectory, as compared to previous rate normalization cycles. And with Richard Fisher and Plosser announcing
their retirements from their posts in April 2015 and March
2015 respectively, this will be perceived as “less heat from the
hawks” on the rate debate among the FOMC participants next
year. Furthermore, their successors (which will be selected by
the boards of their respective reserve banks, and subject to
the approval of the Federal Reserve board of governors) have
not been named. And even when selected to office, these
two new Fed Presidents will not be able to vote on FOMC until their rotation takes place in 2017.