Who will become a new FED leader?

Lael Brainard, one of the Fed governors is being considered for the top job once current Chair Powell’s tenure runs out next February. 

Inflation has run well ahead of forecasts and ‘transitory’ inflation, it turns out, can last a lot longer than Fed officials originally thought. Some might still be clinging to the view that price pressures will blow themselves out but the evidence still points in the opposite direction; that price pressures are broadening and increasing, not withering and dying. This week’s sharp increase in the CPI, taking the annual rate to 6.2%, was not just a shock. A deeper dive into the components suggests that what was once a rise in prices borne of super-sized increases in some supply-challenged components, such as autos, is now a broad-based rise in inflation.

For instance, the Cleveland Fed’s measure of the median CPI (which measures inflation at the 50th percentile) rose 0.6% in the month of October; the highest in the 38-year history of this survey. It was the same for the 16% trimmed mean estimate (which rose 0.7%) and is computed by omitting the price changes that fall in the top 8% and the bottom 8% of all price movements. What’s more, it is not as if the October data were a one-off. Monthly increases in these measures have been moving up sharply in recent months.

This development in inflation is not surprising. We usually see price pressures broaden. Take energy, for instance. A surge in prices quickly lifts pump prices and headline CPI but these pressures can broaden over time if firms that pay higher energy prices start to lift the prices they charge to consumers and firms. With price pressures broadening the question is whether and how the Fed should respond.

Some argue that tighter monetary policy cannot cure supply chain problems so the Fed should do nothing. But then, rate cuts can’t cure a pandemic and yet the Fed still cut last year. As price pressures broaden the case for the Fed to intervene increases. Another point is that inflation is not just a function of supply. Demand is a factor as well and there’s a good case for saying that the government’s spending of around 25% of GDP on Covid support has created too much demand. The Fed can hope to affect demand even if supply is out of reach.

Again, some would say that the economy is still fragile with unemployment high and the Fed should not be trying to cool things down. But the problem with this argument is that if inflation continues to surge, and the Fed falls behind the curve, it will be the market that delivers the demand-sapping medicine via a sharp rise in bond yields. The Fed needs to be in control of any demand-related actions, not following the market in some sort of delayed and clumsy fashion. Into this debate comes the issue of Fed leadership.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said: “We can see a number of reasons why President Biden might want to replace Powell with Brainard. High up on the list are the fact that the Board is already heavily weighted to the Republican side. Another is that Powell has led the Fed at a time when ethical questions have arisen over personal account trading, which has caused two FOMC members to leave early. Brainard is also seen to be more in-tune with climate issues as they relate to banking. And finally, Biden could hope to show that he means business on inflation if he appoints a new Fed Chair. But herein lies the rub, at least with respect to the last of these, as Brainard is widely seen as certainly no more hawkish than Powell and, if anything, slightly more dovish. To mix our sayings unashamedly, it might be more a case of going from ‘the frying pan to the fire’ than ‘rearranging the deck chairs’ as far as the treasury market is concerned”.