The Federal Reserve is widely expected to raise interest rates after its meeting wraps up Wednesday. And investors will be paying particularly close attention to the Fed’s so-called dot plot, which shows where Fed officials think rates will be over the next few years.
But the people behind three of those dots, including Fed chair Janet Yellen and vice chair Stanley Fischer, could be ex-Fed members by some time next year. In addition, there could be new two Fed members as well.
Yellen and Fischer have terms that end in 2018. And several Fed watchers think that President Donald Trump is likely to appoint new leadership at the central bank.
Fed governor Daniel Tarullo too has submitted his resignation, effective April 5.
There are also two vacancies on the Fed’s board of governors. Trump will have the opportunity to nominate people for those three open positions, and likely get them approved by the Republican Senate.
Given that Trump bashed Yellen on the campaign trail for keeping rates too low, many think Trump will name new Fed members that are considered hawkish as opposed to dovish: i.e. more inclined to raise rates than keep them near historically low levels.
So even though most investors now expect the Fed to raise several times this year and a couple of more times in 2018, the market may look at Wednesday’s dot plot and mentally nudge some of those 2018 dots even higher.
“I think we will get replacements for Yellen and Fischer,” said Matt Toms, chief investment officer of Fixed Income at Voya Investment Management.
Toms thinks that the Fed will raise rates three times this year and could do so another three times in 2018.
The Fed could wind up being even more aggressive if Trump is able to quickly make over the central bank’s board of governors though. There are five Fed members on this board, as well as 12 regional Fed presidents.
All 17 provide interest rate targets for the dot plot but not all of them have a vote on monetary policy decisions. The five governors do while the regional bank presidents have a rotating schedule for serving on the Fed’s Open Market Committee that sets rates.
“There is a decent probability that the composition of the Fed next year is more hawkish than it is now,” said Lisa Hornby, a fixed income manager at Schroders, noting that 5 of the dots from permanent voting members are up for grabs.
Higher interest rates have sometimes been a problem for presidents though.
Some blame then President George H.W. Bush’s loss to Bill Clinton in the 1992 election on former Fed chair Alan Greenspan because he raised rates too aggressively in the early 1990s and slowed the economy in the process.
Could Yellen — or her possible successor — do the same? If rates go too high too fast, they could numb the effect of any stimulus that comes from Trump through tax cuts, more government spending on infrastructure and fewer regulations.
Of course, rates are still very low right now and they would remain historically low even after a series of hikes this year and next. And investors seem to be taking the view right now that rate hikes are an endorsement of the economy’s strength.
But that’s a little bit of bullish spin. Sentiment could change if higher rates start to cut into corporate profits and slow the economy.
In other words, Trump should be careful what he wishes for. Rate hikes sounded like a great idea on the campaign, but too many of them could come back to haunt him.
“Rising rates are good for stocks because the Fed is more confident in the economy? That sounds great but historically that hasn’t been the case. Rising rates have meant lower returns for stocks. Investors need to reduce their expectations,” said Robert Johnson, president and CEO of the American College of Financial Services.
Toms pointed out that low rates in the U.S. also aren’t as low as they seem when compared to where they are in Europe and Japan. So if the Fed raises rates several times while the rest of the world’s major central banks keep them steady, that could be an issue.
“The Fed needs other central banks to move away from extraordinary easing. The European Central Bank and Bank of Japan have to step away from their accommodative policies,” Toms said.
And Johnson said no matter who is calling the shots at the Fed next year, Trump will need to get his stimulus plans through Congress in order to keep the economy and markets humming along.
So even though the political landscape has changed, one thing remains the same. The Fed needs help from politicians. It can’t prop up the economy by itself indefinitely.
“The biggest risk right now is the market is pricing in a certain amount of tax relief at corporate and individual level from Trump and Congress. “If it doesn’t come in as assumed that could be problematic,” Johnson said.
