Commentaries

PMC Weekly Review – December 28, 2018

A Macro View – Don’t Fight the Fed?

To say markets have been choppy lately is an understatement. A handful of catalysts have sparked the recent bumpy ride, but could the President’s increasingly frequent critiques of the Federal Reserve (the Fed) be amping up volatility in an already nervous market?

The Fed, established in 1913, operates as the US’s central bank and, among other focuses, serves an important role in setting the country’s monetary policy. When created, the Fed’s private and public leadership was seen as an improvement over the previous and predominately privately owned systems in setting monetary policy oversight. Twelve regional bank presidents (only five of which have voting power at any time) are selected by their respective regional commercial bank representatives, whereas seven individuals are chosen by the President of the United States and confirmed by the Senate to serve on the Board of Governors. Not unlike many other central banks around the world, these members work to meet the Fed’s mandates (currently set to maintain stable prices and maximize sustainable employment) and, at the same time, remain apolitical and unbiased toward the political party in power. However, the latter has not always held true, producing clear examples of subsequent actions that led to turbulent financial markets.

One of the clearest and most recent international examples of political intervention in a central bank’s policies comes from Turkey this past July. In the wake of President Tayyip Erdogan’s re-election and appointment of his son-in-law to the finance minister position, the Turkish central bank left interest rates unchanged despite concerning inflation and market participants’ expectation of a rate increase to stall rising prices. Both Turkey’s financial markets and its currency plunged after the announcement to hold rates steady, and bond rating agencies downgraded the Turkish sovereign debt the following month. Closer to home, the US Fed’s independence was challenged in the early 1970s by then-President Richard Nixon. President Nixon already had a less-than-favorable view of the Fed prior to assuming the presidency in 1968, but under pressure to be re-elected in 1972, coerced the Fed chairman into a more dovish monetary policy stance to keep easy money flowing into the economy. Soaring inflation, and eventually stagflation, came about in part from these policies, with the inflation rate reaching highs not seen since the end of World War II, and eventually topping 12% in 1974.

These are only a few of many examples of cases in which intervention into a central bank’s mandate has seemingly caused calamity. Maybe rightly so, these interferences are viewed as deviations from practiced norms and are not unlike other unforeseen events that spook investors.

Only time will tell whether the current administration’s criticism and attempts at intervention will result in history repeating itself. However, through these times of heightened uncertainty, investors should remember that market volatility is occasionally expected, and those who maintain a long-term focus have the best chance of meeting their long-term objectives. 

Eric Halverson

AVP, Investment Analyst

Source: St. Louis Federal Reserve Bank

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