What a new chair does (and doesn’t) mean for the Fed

It’s not every day that a prospective Fed chair calls for a “regime change,” as Kevin Warsh has famously said. As part of this sea change, he has advocated for rethinking how the Fed views inflation and shrinking the Fed’s balance sheet.

Now, as Warsh succeeds Jerome Powell as chairman, it’s almost certain that the Federal Reserve will undergo some transition, but the degree remains to be seen, according to BOK Financial® Chief Investment Strategist Steve Wyett.

He’s widely regarded as an expert on monetary policy,” Wyett said of Warsh. “He’s also shown he’s willing to challenge the status quo.” Wyett was speaking with Dave Davis in a recent episode of “Your Money Matters” on Oklahoma’s News on 6. You can watch the full interview here.

The path to Warsh’s appointment as chair has been “filled with questions right up until the end,” Wyett said. Some of these questions still persist, though history can yield some information about the potential paths forward. Here are five factors to keep in mind in the months ahead:

1. The call for lower interest rates is not in itself unusual: “Virtually every president wants lower interest rates. The difference now is how openly that’s being communicated,” Wyett said. Lower interest rates tend to spur economic growth, which is positive for presidential approval ratings. In sum, what makes President Trump different from prior presidents is his open advocacy for lower rates on social media.

2. The reason why the Fed lowers rates is important: Normally, the Fed lowers interest rates either to stimulate growth, as it did to counter Covid’s slowing effect on the economy, or simply to bring rates down to a more “neutral” level—that is, a level that is neither stimulative nor restrictive of growth. However, there are some concerns that the reasons behind future rate cuts might be different this time. As Wyett said, “The key question is whether decisions will be driven by the Fed’s mandate or by political pressure. If monetary policy starts leaning more political than economic, that could be detrimental to the broader economy.”

Here’s why: The Fed only controls short-term interest rates. If financial markets lose confidence in the Fed’s credibility to set monetary policy based on the best interests of the economy, long-term rates likely would move higher, Wyett explained.

Plus, there’s inflation to consider. If the Fed cuts rates while inflation is still elevated, inflation expectations could “get out of control,” Wyett said. “We don’t want to repeat history,” he said, referring to the inflation problems that persisted in the early 1980s. “That required very painful policy to fix.”

3. Warsh has been in the Fed before: Warsh was the youngest-ever member of the Federal Reserve Board of Governors, serving during the Financial Crisis. “He was a key architect of the Fed’s response during that period,” Wyett said. However, Warsh stepped down as a Fed governor in 2011 because he disagreed with how much the Fed was buying Treasury bonds to strengthen the economy, arguing instead for greater market discipline. As Wyett said, Warsh’s history shows that he’s “willing to challenge the status quo.”

4. Powell’s decision to stay on the Fed is significant and it may be rooted in concerns that the Fed will become too political: “Jay Powell staying on the board breaks with decades of tradition,” Wyett said. “That’s a strong statement about his concern over preserving the Fed’s independence.”

His decision to stay on also “creates a unique dynamic,” Wyett noted. “But Jay Powell was very clear. He’s not here to try and second-guess Kevin Warsh. He’s not here to try and make the interest rate decision-making process harder.”

5. The change in Fed chair is important—but there are also other factors deciding the health of the economy: “The underlying momentum of the economy is still pretty strong. There’s a disconnect between what we’re reading in headlines and what we’re seeing in the data,” Wyett noted, referring to the resilience in the job market and other positive economic indicators, although risks such as inflation remain.

“There’s no reason for investors to change their plan: stay the course,” he said.