Decision between Powell and Brainard

Even if the two are fundamentally similar in terms of their monetary policy orientation, the personnel changes are of great importance for the future direction of the Fed. On the one hand, because Brainard is even more clearly seen as a supporter of a loose monetary policy, but also because the candidate is taking a much stricter course than Powell when it comes to banking regulation.

“Biden is getting pressure from the left wing of the party to vote for Brainard. But in the midst of the current excitement about inflation, he would seem ignorant if he opted for an even bigger monetary dove, ”says Daniel Alpert of investment bank Westwood Capital.

Commerzbank economist Bernd Weidensteiner also thinks that the US president makes himself “naturally more vulnerable if he nominates Brainard for the top of the Fed”. The Republicans would then “accuse him of fueling inflation”. In any case, many economists and investors are warning that the Fed is underestimating the risk of inflation.

Mohamed El-Erian, Allianz’s chief economic advisor, has been complaining for months that the US Federal Reserve should have started reducing bond purchases, known as tapering, much earlier. Powell had only announced the tapering at the latest Fed meeting in early November.

Last week, El-Erian described the Fed’s stance on inflation as “the biggest misjudgment in decades”. A number of renowned economists have increased their pressure on Powell in the past few days. For example, the former head of the regional Fed in New York, Bill Dudley, demanded that the Fed reduce its bond purchases even faster than it had just announced. Larry Summers, former Treasury Secretary, had made the same point.

The Fed, on the other hand, continues to assume that the current price surge is temporary. In his press conference in early November, Federal Reserve Chairman Powell said he expected inflation to fall again in the second or third quarter. “We’re taking a closer look and will change our policy accordingly.” He expressed his understanding that rising gasoline prices and heating costs hit many people hard, but he opposed a faster tightening of monetary policy. “We don’t think it’s a good time to raise interest rates.” The labor market must first continue to recover.

Investors expect interest rate hikes to be faster

Investors, on the other hand, doubt whether the Fed will stick to this line. Initially, the central bank underestimated the inflation trend in its forecasts for this year. In addition, other central banks around the world rate the risks as higher. Many smaller central banks have already raised interest rates, some significantly. In contrast, the Fed and the European Central Bank are taking significantly more time to tighten.

In both Europe and the US, investors are pricing in earlier rate hikes than the central banks have signaled. In addition, inflation expectations, which are derived from market prices, have recently risen significantly in both regions. In the USA, according to data from the options exchange CME, the futures market is already pricing in an interest rate hike in June 2022 with a probability of 70 percent. That is earlier than the Fed itself has signaled.

The central bank currently assumes that its bond purchases will end at this point in time. After the financial crisis, however, after the end of net purchases, she waited more than a year until the first interest rate hike. According to the forecasts of the members of the Fed’s Monetary Policy Committee in September, half of the members now expect a first rate hike in 2022 – the other half of the members only from 2023.

That could change in December when the Fed releases new interest rate forecasts. According to bond trader Pimco’s US economist Tiffany Wilding, the unexpectedly high surge in US consumer prices in October changed the situation. They had increased by 6.2 percent compared to the previous year – economists had only expected a value of 5.8 percent.

The prices of many retail goods rose faster than expected. Wilding sees the significant increase in rents as a warning sign. These make up around a third of the basket of goods with which inflation is measured and change rather slowly.

The figures indicated that “rental price increases may accelerate faster than expected beyond the pre-recession pace”. The Pimco economist therefore expects the Fed to revise its inflation and interest rate forecasts in December 2021. It assumes that the updated forecasts predict an average of two rate hikes in 2022 and another three to four hikes in 2023. The Fed will therefore probably start raising interest rates shortly after the end of the bond purchases.

The head of the regional Fed in St. Louis, James Bullard, is already in favor of an interest rate turnaround as early as possible next year. The Fed would do well to take a tighter line to adequately address the inflation threat, he told Bloomberg TV on Tuesday. This could also include first stepping up the pace of reducing bond purchases. This means that the process of melting down bond purchases – known as tapering in technical jargon – will be completed in March and not in June 2022. This would also open the door to an interest rate hike much earlier.

So the pressure from the markets on the Fed is high. Whoever is at the helm for the next four years will have to endure this pressure. In purely monetary policy terms, Powell and Brainard do not differ in principle, it is more about differences of degree. “They are in line. Brainard has always supported the Fed’s course in recent years, ”says Commerzbank economist Weidensteiner. The views of both candidates on inflation and the interest rate turnaround were largely identical this year. Brainard, like Powell, agreed that the price hikes would only be a temporary phenomenon.

In the past few months, economists have repeatedly expressed their surprise at how much Powell, a Republican, cares about propping up the labor market and helping all those who have been hit particularly hard by the pandemic – and in return, accepting higher inflation rates to take.

Biden’s team of economic advisors and various Democratic senators have voted in favor of Powell. However, the party is not united behind him. Former presidential candidate Elizabeth Warren recently described him as “dangerous” because he sided with the big financial institutions too much when it came to banking regulation. In addition, Powell and other Fed governors have recently been criticized for buying private securities in the pandemic.

Differences in financial regulation

The differences between Powell and Brainard on the subject of financial regulation are significantly greater. Since Powell took over the leadership of the Fed in 2018, Brainard has voted against the committee’s decisions 23 times, mostly against the relaxation of regulatory requirements for large banks. Fed presidents are usually keen to build consensus among monetary leaders.

The two candidates also disagree on the subject of cryptocurrencies. Brainard, who grew up as the daughter of a US diplomat in the old Federal Republic and in Poland before the fall of the Berlin Wall, has spoken more often than any other governor on the subject of digital currencies in recent months.

She advocates stricter supervision on this issue. She also works to ensure that the Fed “stays at the forefront” in research and development of central bank digital money. China is already in the process of implementing its own digital yuan. “It is therefore very difficult for me to imagine that the US with the prominent position of the dollar in the international payment system would not come with a similar offer,” she said at the end of September. Powell, on the other hand, is more hesitant about introducing a digital dollar.

Brainard is also the driving force in combating climate change. The Fed under Powell is in the process of introducing so-called climate stress tests for banks, which provide information about the environmental risks on their balance sheets. However, the issue is highly political. Especially among the Republicans there are a number of politicians who deny climate change or at least speak out against the issue being dealt with by the central bank.

If Brainard has its way, the Fed could become more active here. “Climate change could have far-reaching consequences for future economic growth and economic activities,” she emphasized at a conference in October.

Politically, the easiest way for US President Biden would be to confirm Powell in office. In view of the tight majority in the Senate, it would be easier for him to get another term of office. A possible compromise could be that Powell gets another term of office and Brainard instead moves to the soon-to-be-vacant post of the Fed’s current vice chairman, Randal Quarals, who is responsible for banking supervision. He recently announced that he would resign in December.

More: US Federal Reserve curbs its bond purchases