The Federal Open Market Committees first policy setting meeting of 2007 on January 30th will mark the start of a regime change within in the Federal Reserve. An annual rotation will strip regional Fed presidents of their voting rights within the FOMC, including Jeffrey Lacker, Sandra Pianalto, and Janet Yellen, and will bring a set of four different presidents to the table, including Michael Moskow, William Poole, Thomas Hoenig, and Cathy Minehan.
While the departure of members with extreme tightening biases, such as Mr. Lacker, would initially infer a more moderate posture within the FOMC, the addition of three decidedly hawkish individuals and one moderate dove has the potential to create one of the most vigilant monetary policy committees in recent memory.
Bernanke - The Beginning of a New Era
2006 Monetary Policy Action
Last year also brought major changes for the Federal Reserve Bank, as Ben Bernanke came in to replace retiring Chairman Alan Greenspan in February 2006. Mr. Bernanke found he had quite a reputation to live up to and faced sharp initial criticism as being too candid and soft on inflation, despite four consecutive rate hikes by the end of June.
The Chairmans biggest misstep started on April 27, 2006 during testimony to Congresss Joint Economic Committee, when he stated that the Fed might pause on raising interest rates even if higher inflation risks persisted. His frank commentary led traders to believe that he lacked commitment in fighting inflation, which sent forex and bond markets reeling as EUR/USD surged 150 points in a day and the TIPS spread jumped 12 basis points in two weeks. The situation worsened on May 1 when CNBC reported that Mr. Bernanke told reporter Maria Bartiromo off the record that the markets had misinterpreted his statements, sending bonds and the dollar tumbling. The Chairmans troubles didnt end there, either. On May 25, a letter that Mr. Bernanke had written to Representative Jim Saxton, chairman of the Joint Economic Committee, noted that inflation expectations were well contained, even though both core and headline CPI had accelerated above the Feds target ceiling to 2.44 percent and 4.2 percent, respectively. This contradiction led the markets to believe the Chairman was ill-informed or simply ignorant of the actual situation. Mr. Bernanke saved himself, however, as he came out swinging with his most hawkish language of the year, saying on June 5 that recent rises in price pressures were unwelcome and that the Fed would make sure that the trend would not continue.
The Fed Chairman managed to prove the naysayers wrong by hiking rates 25 basis points at the first four consecutive Federal Open Market Committee meetings to a high of 5.25 percent. Additionally, the central bank perpetuated a strong tightening bias throughout the year with the help of über-hawks like Richmond Federal Reserve President Jeffrey Lacker, who served as the sole dissenter four times in favor of rate hikes and publicly touted his concerns regarding inflation risks. By the end of the year, the head of the worlds most widely watched central bank had gained the publics trust as headline CPI decelerated to 2.5 percent from the May high of 4.3 percent and core CPI slipped to 2.6 percent from the September peak of 2.9 percent.
2007 More Hawkish Than Ever?
The 2007 Lineup
The voting rotation schedule of the Federal Open Market Committee is set to bring about further change in 2007, and this panel of members could be more hawkish than ever. While overt hawks like Mr. Lacker, and moderates such as Cleveland Federal Reserve President Sandra Pianalto will be on their way out, the replacements look eager to fight inflation as well.
An In-depth Look:
Poole (Moderate Hawk) - St. Louis Federal Reserve President William Poole may be one to follow in Mr. Lackers footsteps, as he has proven that he is willing to vote against the majority, as he did in May 1998 (voted for tighter policy) and June 2001 (voted against easing). However, when Mr. Poole filled in for retired Atlanta Federal Reserve President Jack Guynn during the October and December 2006 meetings, he opted to vote along with the consensus to hold rates steady. Does this mean he will show a more dovish side in 2007? On January 17 Mr. Poole stated, I think we are well positioned where we are (on interest rates)?I am often described (as) an inflation hawk. I havent changed my mind about that, and therefore I think that only if the new information is pretty compelling would I want to take a position that we ought to be lowering rates. And I absolutely dont rule that out. Mr. Pooles stance is similar to that of most of the monetary policy committee members, as his comments reflect a cautious approach to price pressures. Nevertheless, should consumer price data signal that inflation has yet to ease significantly, Mr. Poole could easily return to his old hawkish self.
Hoenig (Moderate Hawk) - Also on the hawk side of the scale is Kansas City Federal Reserve President Thomas Hoenig, who has dissented three times against easing monetary policy: once in 1995 and twice in 2001. However, similar to Mr. Poole, Mr. Hoenig has shed some of his extremely hawkish leanings since mid-2005 and said as recently as January 19, monetary policy is moderately restrictive?which should bring down inflation over time. Mr. Hoenig remains optimistic on the US economy, though, noting that mortgage defaults have been mainly limited to the subprime sector, having minor impact on the economy overall and he does not see much impact from a higher minimum wage while he expects productivity growth in the near term to be 2 percent or better.
Moskow (Very Hawkish) - Meanwhile, Chicago Federal Reserve President Michael Moskow has become increasingly hawkish since the departure of former Chairman Alan Greenspan after consistently voting with consensus in 1995, 1997, 2001, 2003, and 2005. However, he reflected a stronger-than-usual tightening bias when he said on January 10, My predominant concern remains the risks to the inflation outlook?there is still the risk that resource pressures or other factors...could prevent actual inflation from falling in a timely fashion?We need to continue to be vigilant in monitoring the risks to the inflation outlook.
Minehan (Moderate Dove) - On the flip side, Boston Federal Reserve President Cathy Minehan will be joining the voting ranks of the FOMC as a moderate dove. However, her impact may be limited as she is simply replacing the dovish tendencies of San Francisco Federal Reserve President Janet Yellen, whose voting rotation ended in 2006. Additionally, Ms. Minehans record shows that she typically votes along with consensus, and her recent statement on January 12 that core inflation?may be slow to taper off signals that she will not be one to rock the FOMCs boat and remains concerned about price pressures consistent with broad central bank view.
Where to Next 5.50% or 5.00%?
All in all, the 2007 FOMC member balance falls more on the hawkish side. Does this mean well see a higher Fed funds rate? Probably not. If anything, the posturing of the new voting members will simply keep the FOMC neutral until later in the year, as interest-rate futures show traders pricing in an 8 percent chance of a rate cut in May, down from 46 percent a month ago. Clearly, this is completely data dependent, as a surprise surge or drop in inflation could lead the vigilant FOMC to counteract a rise or decline in price pressures. Nevertheless, the markets will be keen to hone in on commentary from the new voters following the Feds rate announcement on January 31 in an attempt to gauge their outlook for the year.
There are additional variables as well. First, Mr. Moskow and Ms. Minehan have announced their retirement from the Federal Reserve, with Mr. Moskow set to depart in August while Ms. Minehan has yet to specify a date. Furthermore, there is still a vacant position available in the Board of Governors, as Roger Ferguson, Jr. has yet to be replaced following his retirement in April 2006. Thus, there is the potential for the FOMCs dove/hawk scale to be tipped in either direction, and creates an even more data-dependent environment for the central banks rate decisions.
