Why the next Fed chief matters in the US — and the Philippines

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DAN STEINBOCK

Janet Yellen’s term is ending at the Federal Reserve. With new appointments, President Trump can indirectly shape US monetary policy for years to come. The Philippines is not immune to policy change— or policy missteps.

IN September, the Philippine central bank kept its key interest rate unchanged as widely expected. In leaving the benchmark rate at 3 percent, the Bangko Sentral said it expected inflation to stay within 2 percent to 4 percent from this year through 2019.

While the planned tax reform program could stoke price pressures, the BSP could still raise rates to limit overheating risks in the economy and to support the peso. After all, major central banks are tightening, the US Federal Reserve is likely to have one more increase in December and the European Central Bank could begin it’s exit from quantitative easing by spring 2018.

The BSP has kept its inflation forecasts for 2017 and 2018 at 3.2 percent, unchanged from previous estimates. The target for 2019 is also 3.2 percent. Yet, realities may prove more challenging, especially as the Fed moves ahead.

Since Yellen’s term will end on February 2018, President Trump will soon select the next Fed chief and several new members of the Fed Board. Consequently, he will shape US monetary policies for years to come.

Trump’s current shortlist features half a dozen viable candidates. In line with his ‘America First’ approach, he is likely to ignore the international implications of the next Fed chief. He is likely to choose a candidate that will not prove too independent and who will prioritize Main Street, not Wall Street, and one that will support his proposed fiscal expansion.

Hawks and doves
The Fed has a dual mandate to maintain stable prices and full employment. Monetary “hawks” tend to stress prices at the expense of jobs, whereas “doves” tend to focus on jobs at the expense of prices.

Kevin Warsh is a “hard money hawk” with intimate ties to Wall Street. Married to the billionaire heiress Jane Lauder, he has served as Morgan Stanley’s M&A executive and President Bush’s director of the National Economic Council. At just 35 years old, he was the youngest appointment in the Fed. Warsh is a Greenspan-like free-market advocate. In 2007, only months before the global plunge, he argued that financial innovation made the system safer.

Recently, Trump also met Stanford’s accomplished John B. Taylor who believes that the global crisis was caused by flawed macroeconomic policies. Interest rates were kept too low for too long, which led to the housing boom. Taylor has cautioned the Fed to move away from quantitative easing measures and to opt for a more stable monetary policy.

Gary Cohn is Trump’s Director of the National Economic Council and his chief economic adviser. Unlike Warsh and Powell, Cohn is a registered Democrat and former president and COO of Goldman Sachs. Unlike his rivals, he supports reinstating the Glass-Steagall legislation, which would separate commercial and investment banking.

After law school, Fed governor Jerome Powell worked as an associate for an investment bank and private equity giant Carlyle Group. He served as an assistant secretary and undersecretary of the Treasury under President George H. W. Bush. He has solid Republican credentials and is seen to represent institutional continuity.

Trump could also opt for the incumbent Fed chief Janet Yellen. While in the past he has criticized some of Yellen’s actions and her Democratic legacies, he has also announced that he is a low-interest-rate person like Yellen.

Fiscal expansion amid Fed’s normalization
Fiscal expansion— a $1 trillion dollar infrastructure plan—is central to Trump’s agenda. When he developed his infrastructure plan, interest rates were close to zero. But as the Fed is normalizing—about to hike up the rates and exiting from quantitative easing—the plan will be a lot more expensive to execute.

“If we raise interest rates and if the dollar starts getting too strong, we’re going to have some major problems, Trump warned already in summer 2016. That is now the reality. He can no longer rely on the Fed to ease and thus to monetize the debt issuance.

Trump needs low rates and a weak dollar, while the Fed is raising rates and boosting the dollar. He cannot mitigate the realities of normalization, but he could slow its pace by selecting a monetary dove. In this view, neither Warsh nor Taylor will do. The former would make Trump’s fiscal expansion prohibitively costly; the latter’s penchant for conservative stability would undermine infrastructure debt-taking.

After a September report that Trump had met with Warsh, stocks fell slightly before recovering, while Treasury bonds saw a significant sell-off and yields rose. From the White House’s standpoint, a monetary hawk would hurt equities while boosting bond yields.

In this view, the appointment of Powell or even Yellen would mean continuity; that is, support equities while keeping bond yields low. That would be in line with Trump’s fiscal plans.

Dr Dan Steinbock is the founder of Difference Group and has served as research director at the India, China and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see https://www.differencegroup.net/

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