Market Commentary


The Future of the Fed


Jerome Powell and the Future of the Fed
Surrounded by many other political and economic stories, a new Federal Reserve Chair might seem unimportant. However, the US Federal Reserve System is one of the most important players in the global economy and a key influencer of the stock market. On November 2, President Trump named Jerome “Jay” Powell as his nominee for Fed Chair and, after what is anticipated to be a shoo-in Senate approval, Powell is set to take the reins of the Fed in February 2018.

So what, if anything, changes with this appointment?

The Fed’s Goals
To understand what might change, it is important to understand the Fed’s role. So first, a bit of boring background on the Fed: The Federal Reserve supervises and regulates the US banking system in general. Its two key areas of focus are maximizing employment and stabilizing prices. It is also seen as a key guard against financial crises. Of the various responsibilities, publications, and mechanisms it uses, the Fed is most widely known as the entity that sets US interest rate targets.

Appointing a Chair

There are seven members of the Board of Governors for the Fed. Each of these is chosen by the President, approved by the Senate, and serves a fourteen-year term. The Chairman of the Fed must be selected from this Board and is also chosen by the President. The Chairman serves a shorter, four-year term. The Chairman of the Fed sets the tone for the Fed and for interest rates. Chairs are usually viewed as “hawkish” if they are in favor of raising interest rates to fight inflation and price bubbles, or “dovish” if they favor lower interest rates to foster lending and increase consumer spending. As an example, Paul Volcker led the Fed when the Federal Funds Rate was raised to 20% in 1981, and is probably the most famous Fed hawk.

Powell’s Appointment: A Drastic Change to More of the Same
The appointment of Jay Powell is notable for many reasons. It marks the first time in decades that a Fed Chair has not been appointed for a second term. While Fed appointments have traditionally been non-partisan, this move is a bit different. Since Ronald Regan, every president who had the option to reappoint a Fed Chair that was nominated by the opposing political party has done so: Regan reappointed Paul Volcker, Clinton reappointed Alan Greenspan, and Obama reappointed Ben Bernanke. The Trump administration considered reappointing Yellen, a democrat appointed by Obama, but decided to change this trend. Powell is a republican and former investment banker who was partner at a famous private equity firm, the Carlyle Group. He is also a lawyer with a law degree from Georgetown, not a PhD economist like the last three fed Chairs.
That said, there may not be that much of a difference in how the Fed acts going forward. Powell is known as a bipartisan dealmaker and has been serving on the Fed since Obama appointed him to the Board in 2012. Indeed, before joining the Fed, Powell was a visiting scholar at the Bipartisan Policy Center in Washington. Powell has generally been supportive of Yellen’s policies. In his testimony to the Senate on November 28, he made it clear that he is a proponent of gradual rate raises, provided that economic activity supports those raises. He also made it clear that he is a strong believer in an independent Fed. Given some of Powell’s statements and his Wall Street background, most observers believe the biggest change between the two Chairs will be a more lenient take on bank regulations going forward.

interest-rates-1Implications for Wall Street and Your Portfolio
Wall Street does not anticipate any dramatic departure from Yellen’s gradual raises. According to a recent poll by Reuters, the Street expects the Fed to raise rates three times in 2018. With one more rate hike anticipated in mid-December, consensus anticipates three rate raises each in 2017 and 2018: more of the same.
As these hikes happen, the price of bonds are likely to decrease. In particular, longer-term bonds with lower coupons will be especially susceptible to interest rate changes. Higher rates can also put the brakes on the stock market. As rates rise, investors move money away from stocks and towards new bond issuances. Rising rates also mean that lending tightens which can slow down the economy and decrease corporate earnings.
So, what is our take? Catamount thinks that gradually rising rates, especially when rates are near historic lows, is a prudent use of the Fed’s power. These raising rates should also benefit lenders, like banking stocks, which are a sizeable position in Catamount’s portfolio. As rates rise, banks’ earnings do as well as they are in the business of lending at the prevailing market rates. The Fed is also very vocal about tying interest rate increases to inflation increases. If it does this, corporate earnings should have room for growth and support the fundamentals that are driving the market leaders right now. This type of environment will suit active managers like Catamount better. We are constantly looking at both fundamental and technical metrics to find the right candidates for your portfolio. As always, if you have any questions, give us a call!