Unanimous Consent Needed to Cut Rates?
While markets see a dovish Fed because it’s an election year, and believe it’s only a matter of time before the rate cutting cycle commences as growth slows and labor market softens, I believe that Powell will not support a rate cut this year without unanimous consent while inflation remains above target.
His tenure as Fed chair has come with the lowest amount of dissenting votes since Volcker himself, with about 1% of votes dissenting since the pandemic.
He fancies himself to be a student of Volcker and wants to make sure that inflation returns to target in a sustainable way. He does not want to be Arthur Burns 2.0, the Fed chair that caved to political pressure and cut rates to address growth concerns in a stagflationaey backdrop.
Election dynamics will play a role here and the election this year works against Powell’s idea to start cutting rates unless he has unanimous consent because dissenting votes will open him and the Fed up to intense criticism from Trump and Republicans as seeking to help the incumbent. If Trump wins, the Fed’s independence may come under pressure, particularly if he views a rate cutting decision with dissent as a political choice. Powell needs to steer clear of this dynamic.
As a result, there is an extremely high bar to beginning the rate cutting cycle. Furthermore, the makeup of the voters this year presents a problem for Powell too. Currently we have four voters that are against cutting rates soon and believe that there may be further upside risks economy and inflation than they observed in December.
Governor Bowman is a well known hawk and has no cuts penciled in this year. It will take a lot to get her to move.
Waller, another governor, just authored a speech entitled “What’s the Rush” and doesn’t seem keen on cutting in the first half of this year and acknowledges upside risk to his forecasts from December are already possible.
Bostic is a voter this year looking for two cuts but has said he sees potential “pent up exuberance” in the economy that is awaiting the Fed once it starts cutting.
Barkin is also a voter this year who seems to be at either zero or one cut. He seems to be most concerned about the loosening financial conditions impact on wealth driving inflation and inflation in expectations higher.
So currently, there are four pretty hawkish voters who would have to be convinced that the economy is going to slow and inflation going to fall even more rapidly now than they believed in December, after better than expected data to start the year. A lot is going to have to go wrong in the economy in order to get them to change their views and support a cut.
The only real way we are going to get there is for the Fed to stay on the higher for longer track, price out more cuts this year to allow financial conditions to tighten again, and let risk markets falling help them bring inflation back down to target. Lower stock prices will bring forth more layoff and ease wage pressures enough to help bring down services inflation. The housing market momentum will soften when folks realize lower mortgage rates aren’t right around the corner.
If the Fed really wanted to move this along faster, they could get more aggressive with active management of its balance sheet reduction/QT program with MBS sales or a reverse twist to sell long duration holdings, things that Waller has suggested are on the table but they don’t seem imminent.
So what we have is a Fed that is using interest rates as primary tool to bring inflation down and still believes that this is the preferred way to do it. So it’s higher for longer messaging coming out of next week’s meeting with a high bar to reverse course and cut rates that could help kickstart the asset price correction cycle necessary to tighten financial conditions and achieve the last mile on getting inflation back to 2%.
Failure to do so here is only going to allow risk assets to rip further and make their job even that much harder later.
