The announcement took longer than expected, but President Biden nominated Jerome Powell for a second term as chair of the Federal Reserve. It was largely expected that Powell would be renominated, but some doubts crept into markets and market participants began to contemplate the possibility that Lael Brainard would be nominated instead. Brainard has been on the Federal Reserve Board of Governors since 2014 and is perceived to be more dovish by many than Powell and a tougher bank regulator. Instead, Brainard was nominated to serve as the Vice Chair of the Federal Reserve.
NPP does not believe that there is a huge difference between Powell and Brainard. We thought he should be reappointed because we did not see a compelling difference between him and Brainard. If President Biden wanted to tilt the Federal Reserve in a different direction, then Brainard was unlikely to be as dovish as some of her supporters believe although she may have been more accommodative than Powell regarding monetary policy. It’s likely she would have been tougher on banks from a regulatory perspective.
Equities and bond yields initially jumped on the news although the S&P 500 ended the day down. The dollar rallied while gold prices fell. Inflation is a big risk now and at this point we think that market participants fear the possibility of inflation being perpetually too high as a bigger risk than monetary accommodation being removed too quickly.
Powell is a Republican and was nominated to the Board of Governors by President Obama for his initial term before being nominated by President Trump to be the Federal Reserve Chair. There is a tradition of the Federal Reserve trying to be apolitical and of Fed Chairs being renominated by Presidents or parties that did not initially nominate them. In this hyper-partisan atmosphere, we see the value in renominating someone who is well-respected on both sides of the aisle. Powell does have his detractors in both parties. Some Democrats think he is too lenient on banks, while some Republicans and Democrats think he has been too dismissive of inflationary risks. To be fair to Powell, this criticism can be thrown at the Federal Reserve Board. It is not specific to him.
NPP believes that monetary accommodation has been excessive for a while regardless of party affiliation. We are not in the higher inflation for longer camp. However, we do think Powell and the Federal Reserve have erred in not moving more quickly to reduce monetary accommodation. They thought that the full employment side of their dual mandate was more at risk by becoming less accommodative and in our opinion made an error in judgement. NPP does not believe there is much that monetary policy can do to clear up virus concerns or supply chain problems. Inflation can be a pernicious force that lowers living standards. Once it appears it can be hard to stop it without causing a recession. Ultimately, we think that inflation will come back down. Supply chain problems will ease and hopefully people will reduce their goods purchases in favor of vacations, restaurants, and other experiences when COVID-19 shifts to the endemic phase. Demographics will also likely continue to exert deflationary pressures although it is possible that a shrinkage in prime-age workers may counteract that. Nevertheless, we think they should have tapered sooner and should hasten the end of their bond-buying campaign.
The question can rightly be asked why NPP thinks Powell should be reappointed if we have concerns with some of his policies. The answer is there wasn’t an alternative considered for the position. There is not an appetite for a hawkish Fed Chair akin to Chair Volcker or at times Chair Greenspan in Washington. That time may come, but we are not there yet. NPP does not think there is much of a difference between Powell and Brainard. We believe Biden’s decision to maintain the status quo is the right decision for the wrong reason. While we are circumspect of some of the decisions made by the Federal Reserve, it does not change our outlook for the markets. Equities are not cheap, but neither are they outrageous especially when comparing cash returns to bonds. We do feel multiples will fall slightly in 2022.The coming quarters should be choppier than 2021 has been, but strong earnings growth should continue to support equity markets. This economic expansion still has legs and while bonds may move higher, they are unlikely to move high enough in the United States or overseas to create a compelling alternative to equities.