US IN FOCUS Who Matters In The FOMC?

ƒƒ Sensing the Fed is finally on the cusp of normalizing pol- throughout the last few years) and the QE program com- icy interest rate, there will be a sharper intensity in mar- ing to an end in the next FOMC meeting on 28-29 Oct 2014, ket’s Fed watching, not just about the FOMC decisions the market is sensing that the Fed is finally on the cusp of and the minutes, and also Fed officials’ commentary. normalizing the FFTR. The market consensus is currently ex- pecting the Fed’s rate-lift off to take place in the summer of ƒƒ A recent St. Louis Fed report highlighted that between 2015 (we are expecting it to be announced in the 16-17 June 2008 and 2014, the Fed Reserve bank presidents ac- 2015 FOMC). Thus, there is increasingly intense interest in Fed counted for all of the dissents since 2008 which is un- watching, both in terms of the FOMC decisions & minutes as usual according to the authors. In prior years, both Fed well as the comments from senior Fed Reserve officials that Presidents and Fed Board Governors dissented. are participants in the FOMC (voters and non-voters).

ƒƒ In 2014 FOMC decisions so far, Charles Plosser and Rich- First, it is instructive to have a bit of background to the mon- ard Fishers are the key dissenters. And we believe that etary policy formulation process within the US Federal Re- they may be joined by Loretta Mester in the dissent serve. The Federal Reserve controls the three tools of mon- camp for the remaining FOMC decisions in 2014. But etary policy--open market operations, the discount rate, and their dissent is unlikely to have a large effect on policy, reserve requirements. The Board of Governors of the Federal as Fed Chair will still be able to press ahead Reserve System is responsible for the discount rate and re- with majority support rather than seeking unanimity serve requirements, and the Federal Open Market Committee (7-3 votes in the base case scenario). (FOMC) is responsible for open market operations. Using the three tools, the Federal Reserve influences the demand for, ƒƒ In 2015 FOMC, Richard Fisher, Narayana Kocherlakota, and supply of, balances that depository institutions hold at Loretta Mester, and Charles Plosser will rotate out of Federal Reserve Banks and in this way alters the their voting positions, and the incoming voters are rate. The is the interest rate at which de- Chicago Fed President Charles Evans (Dove), Rich- pository institutions lend balances at the Federal Reserve to mond Fed President Jeffrey Lacker (Hawk), Atlanta other depository institutions overnight. Fed President, Dennis Lockhart (Centrist – tentative dovish bias), and San Francisco Fed President, John The FOMC which consists of 12 members--the seven mem- Williams (Dove) which we should pay more attention bers of the Board of Governors of the Federal Reserve to. So it seems there will be more doves replacing the System; the president of the of New departing hawks (Fisher and Plosser) for now, which in York (permanent seat); and four of the remaining eleven our view benefits Yellen’s dovish approach. Reserve Bank presidents, who serve one-year terms on a rotating basis. Non-voting Reserve Bank presidents attend ƒƒ The rest of the important 2015 FOMC voters are the 5 the meetings of the Committee, participate in the discus- Fed Board Governors and the New York Fed Presi- sions, and contribute to the Committee’s assessment of the dent, William Dudley. It is unlikely for US President economy and policy options. (Information taken from Obama to fill the 2 vacant Governor seats next year, so http://www.federalreserve.gov/monetarypolicy/fomc.htm) the number of FOMC voters is expected to remain at 10 in 2015. Currently, there are 2 vacant governor seats which are unlike- ly to be fill anytime soon as there is not much Senate session days left before the mid-term elections on 4 November 2014, and the Senate has taken an average of 119 days to confirm Who Are The Key Players In 2014 FOMC? Obama’s 10 Fed Board nominations since 2009. So there are In response to the onset of the 2008 financial crisis, the US only 10 voting members in the 2014 FOMC comprising of: Federal Reserve started cutting its benchmark policy interest rate, the Fed Funds Target Rate (FFTR), first on 18 Sep 2007, by 1. Fed Board of Governors, Chair Janet Yellen an initial 0.5% cut to 4.75%, and by the time we reached the 2. Fed Board of Governor, Vice Chairman Stanley Fischer 10th rate cut on 16 Dec 2008, it was lowered by a final 0.5%, (permanent FOMC voter) to between 0% and 0.25% where it has remained ever since. 3. Fed Board Governor And when the aggressive cuts in short interest rates proved (permanent FOMC voter) to be insufficient, the Fed also embarked on unconventional 4. Fed Board Governor quantitative easing (QE) programs as part of their expansion- (permanent FOMC voter) ary monetary policy to help turnaround the ailing US econo- 5. Fed Board Governor Daniel Tarullo my and the sharp increase in unemployment. (permanent FOMC voter) 6. New York Fed president and Vice Chairman, William Dudley After quite a few false starts (of expecting interest rate hikes (permanent FOMC voter)

QUARTERLY GLOBAL OUTLOOK 4Q2014 18 UOB Global Economics & Markets Research US FEDERAL RESERVE IN FOCUS

7. Dallas Fed President Richard Fisher tion than is suggested by the Committee’s stated forward (voter in 2014 FOMC) guidance.” 8. Minneapolis Fed President, Narayana Kocherlakota (voter in 2014 FOMC) Will There Be More Dissents In 2014? 9. Fed President Loretta Mester If the US remains on its current course of continued, moderate (voter in 2014 FOMC) improvement (both in the economy and the labor market), 10. Philadelphia Fed President Charles Plosser then both Plosser and Fisher will likely continue to dissent (voter in 2014 FOMC) in the Oct 2014 and Dec 2014 FOMC meetings. And we note that both Plosser and Fisher will be rotated out of their voting An Interesting History Of FOMC Voting & Dissent roles in the 2015 FOMC, so they probably have to make their In a recent report published in the 3Q 2014 Federal Reserve voices heard louder (via their dissent votes) in the last 2 FOMC Bank of St. Louis Review (16 Sep 2014), the authors, Daniel decisions of 2014. The question is whether anyone else will Thornton and David Wheelock, found that over the period be joining them in voting against policy decision. 1957-2013, Fed Reserve bank presidents dissented 241 times, and Fed Governors dissented 208 times. While the number of We note that the recently appointed Cleveland Fed Presi- dissents by governors surpassed the number of dissents by dent, Loretta Mester, began her career in the Federal Reserve presidents in many years, Thornton and Wheelock noted that Bank of Philadelphia where she rose to the position director presidents have accounted for all but four (72 of 76) dissents of research at the Federal Reserve Bank of Philadelphia and between 1994 and 2013. If the period is narrowed down to chief policy advisor prior to her current appointment. Since between 2008 and 2014, then the Fed Reserve bank presi- Mester retained her role under the hawkish Philadelphia Fed dents accounted for all of the dissents since 2008 which is president Plosser, the initial expectations were that her views unusual according to the authors. The report also found that would likely align with his. That said, she has voted for the “over the FOMC’s history, Fed Reserve Bank presidents more FOMC monetary policy action in the last 3 FOMC decisions, often dissented in favor of tighter policy than easier policy, unlike her former boss. Her recent comments (5 Sep 2014) whereas a majority of dissents by Federal Reserve governors noted that while the “exact timing” of rate hikes depends on were in favor of easier policy.” But the report also noted that the economy, Mester opined that the Fed is much closer to not all dissents were for or against the current policy stance achieving its economic goals than it has been for a long time, but the voter “dissented because he or she disagreed with as the economy is on firmer ground. She also wants the Fed language in the Committee’s statement about possible future to make clearer that the timing and pace of future interest changes in policy.” rate hikes will be driven by the performance of the economy although she declined to say when she thinks the lift-off will Of course history cannot serve as an accurate guide to be. how the current FOMC members will vote and we do have two new FOMC board Governors (Stanley Fischer and Lael In comparison, Minneapolis Fed President, Narayana Kocher- Brainard, confirmed by Senate in June 2014) and a new Fed lakota’s latest comments (22 Sep 2014) warned against raising President (Loretta Mester who succeeded Sandra Pianalto as interest rates with inflation so low and opined the unemploy- Cleveland Fed President with effect from 1 June 2014). ment rate overestimates labor market recovery. Instead, he advocates that the Fed to set the goal to bring inflation to 2% So far in 2014, we have went through 6 FOMC and three were to avoid “European and Japanese” situations and proposed passed with unanimous decisions (January, April and June) the Fed set a 2-year time horizon to achieve its 2% inflation while the other three were passed with dissenters. target. This puts him clearly in the dovish camp, as opposed to Plosser and Fisher. In March 2014 FOMC, Narayana Kocherlakota dissented due to the language used in the statement and not against As for the New York Fed President and Vice Chairman, William the policy stance. However, in the July 2014 FOMC, Charles Dudley (permanent voter in FOMC), his recent comments (22 Plosser dissented as he objected to the Fed’s guidance of Sep 2014) noted that he would be “very happy” to be able keeping short-term interest rates near zero for a “consider- to raise rates some time in 2015 if conditions warrant. But able time” after its bond-buying program ends. In the Sep- he also stressed that it was important to practice patience tember 2014 FOMC, Charles Plosser dissented for the second rather than risk a premature rate hike “just for the sake of rais- straight meeting with the same objection and he was joined ing them.” He also commented it is not yet clear how large by Richard Fisher who dissented on similar grounds as he “be- or small the central bank’s balance sheet should be in the lieved that the continued strengthening of the real economy, long term. And in unusually direct remarks about the US cur- improved outlook for labor utilization and for general price rency from the central bank, Dudley said “If the dollar were stability, and continued signs of financial market excess, will to strengthen a lot, it would have consequences for growth.” likely warrant an earlier reduction in monetary accommoda- Thus, our read is that Dudley is still and will remain on Yellen’s

QUARTERLY GLOBAL OUTLOOK 4Q2014 UOB Global Economics & Markets Research 19 US FEDERAL RESERVE IN FOCUS

side in the dovish camp. are likely to be in the Dove camp (Evans acknowledged the significant improvements in the labor market but thinks in- Thus if we were to pick another FOMC voter likely joining the flation is nowhere near target and it remains appropriate to dissent camp in October and December, we think Mester is keep rates low till well into 2015 [July 2014] while Williams most likely given her recent opinions and her long working still believes there is significant slack in labor market while relationship with Plosser, and that certainly increase some he is not concerned about inflation at all, and rate hikes are pressure on the doves within voting FOMC members. We not likely to happen till middle of 2015. And even if rates are assume that the Fed Board Governors, Dudley & Kocher- hiked, the process is likely to be very gradual so as not to up- lakota will remain supportive of Yellen, so even if we get set the markets [22 Aug 2014]). one more dissent, the margin will still be a comfortable 7-3 in her favor, and she will still be able to press ahead And while Lockhart is widely considered to be a centrist, we with majority support rather than seeking a unanimous viewed him as having a dovish bias based on his latest com- agreement. ments (He expected changes to the Fed policy statement in upcoming meetings and he said the Fed is still focused on a Looking Into 2015 FOMC mid-2015 rate lift-off. He is not worried about inflation and Going into next year, the composition of the 2015 FOMC will he is one “who prefers we let a little more time pass in order change. The 5 current Fed Board Governors will remain as to have the evidence accumulate that we are on a solid track will the New York Fed President and Vice Chairman, Wil- and we are likely to stay on that track.” [23 Aug 2014]) Lacker liam Dudley who has a permanent vote in FOMC. There is probably the sole hawk within the incoming Reserve Bank remain 2 vacancies on the Fed Board of Governors which we Presidents (In early August, Lacker warned that the market think US President Obama will have a difficult nominating may be underestimating the pace of Fed Reserve rate tight- and for the US Senate to confirm their appointments in 2015 ening cycle over the next two years. And in the September because of 1) the uncertain outcome for the 4 November FOMC, Lacker identified himself as the lone dissenter on the 2014 mid-term elections which could shift the power balance Fed Reserve’s updated exit strategy plan and explained his from Democrats to Republicans in the Senate in 2015, and 2) opposition is due to the Fed’s plan to keep holding mort- it is likely to be another politically difficult year for Obama in gage-backed securities in their updated exit strategy. Lacker 2015 as the debt ceiling negotiations will likely re-surface to also previously opposed to Fed’s buying of MBS as he felt it haunt us again in the odd-numbered years where there are gives an advantage to that sector of borrowings over other no US presidential and Congressional elections. types of borrowings by consumers).

As for the four Reserve Bank Presidents, Richard Fisher, Na- So it seems that in 2015, there will be more doves replac- rayana Kocherlakota, Loretta Mester, and Charles Plosser will ing the departing hawks (Fisher and Plosser) for now, rotate out of their voting positions in 2015 FOMC but will re- which in our view benefits Yellen’s dovish approach to de- main as non-voting Reserve Bank presidents attending the liver forward guidance for the eventual rates lift-off at a more meetings of the FOMC. Replacing them as voters in the 2015 gradual trajectory, as compared to previous rate normaliza- FOMC will be: tion cycles. And with Richard Fisher and Plosser announcing 1. Chicago Fed President, Charles Evans (Dove) their retirements from their posts in April 2015 and March 2. Richmond Fed President, Jeffrey Lacker (Hawk) 2015 respectively, this will be perceived as “less heat from the 3. Atlanta Fed President, Dennis Lockhart (Centrist – ten- hawks” on the rate debate among the FOMC participants next tative dovish bias) year. Furthermore, their successors (which will be selected by 4. San Francisco Fed President, John Williams (Dove) the boards of their respective reserve banks, and subject to the approval of the Federal Reserve board of governors) have And these will be the ones we will be watching them not been named. And even when selected to office, these closely in addition to the other six permanent voters on two new Fed Presidents will not be able to vote on FOMC un- the FOMC. As far as we can tell for now, Evans and Williams til their rotation takes place in 2017.

QUARTERLY GLOBAL OUTLOOK 4Q2014 20 UOB Global Economics & Markets Research