EDITORIAL: Understanding the Fed’s change of tone

In the debates about central bank independence the focus is always on how sensible policy can often conflict with the electoral aims of politicians, and whether the latter would try to wield undue influence on the institution. But is this always the case?

Can investors and traders in financial markets, whose decisions largely determine the direction of asset prices, play an equally damaging role? That’s a debate that gathered pace in 2018 when US Federal Reserve chair Jay Powell seemed to be backtracking on the central bank’s rates path. 

It is important to remember that leading to that period Powell, who only took office in February 2018 after President Donald Trump decided against reappointing Janet Yellen, had come under furious attack from the president, who blamed rate increases for a slump in stock markets.

There was even speculation that Trump was exploring ways of removing the chair, though it was not clear if there was a constitutional mechanism to enable him to do that. That speculation was credible enough for Powell to publicly state that he would not leave his job if Trump asked him to.

So when the chair started to soften his message, questions were raised about whether he had been swayed by the president, who had publicly declared that he was “not even a little bit happy” with his appointment

Already in November there were signs of a departure. In October, Powell said rates were “a long way” from neutral. The following month that had changed to something a bit more dovish. He said rates were “just below the broad range of estimates of the level that would be neutral for the economy — that is, neither speeding up nor slowing down growth”. 

During a panel discussion early in January, which also featured his two most recent predecessors, Yellen and Ben Bernanke, Powell identified another culprit for his change of mind. And it wasn’t a person called Donald Trump. In fact it wasn’t a person at all. At least not an individual.

While he thought the economy remained on a solid footing, he still said the Fed would be “patient” in increasing rates and noted that the markets had sold off, partly in anticipation of a weaker economy. Some analysts were even talking of a recession in the next year.

They were, Powell said, way ahead of the data. So the implication was that the change in tone was in spite of, rather than because of, the economic performance.

Even by these standards, the Fed’s statement this week, which some analysts took to indicate that the next move might even be down, took markets by surprise. In December it had told markets to expect two hikes in 2019.

The rand ended up as one of the main beneficiaries, with its latest gains making it the best performer against the dollar in 2019 so far.That's because lower rates in the US increase the appeal of holding assets denominated in other currencies that offer higher returns.

Powell's motivation cannot be a weaker economy, even after the government shutdown that helped push jobless claims this month to the highest since September 2017. Data on Friday will probably show that US employers added jobs for a record 100th month in January while unemployment remained at the lowest since the late 1960s, according to Bloomberg surveys.

Investors will take Powell at his word when he says Trump did not influence his policy stance, though the latter going on Twitter on Wednesday to celebrate the markets’ response to the policy makers’ dovish statement won’t help.

The other logical conclusion is that Powell was spooked by the market selloff in December, which will raise concerns that the bank will now be influenced by short-term fluctuations in market sentiment.

As the debate in SA has shown, central banks cannot be blind to broader developments in the economy and markets, but should they be ruled by them? The Fed’s miscommunication has indicated that it errs to the latter, and that cannot be a good thing.