Back in December 2018, the Federal Reserve announced its fourth interest-rate hike of the year and released information suggesting most members of the Federal Reserve Board anticipated two or three additional hikes in 2019. Federal Reserve chairman Jerome Powell also referenced the expectation of two rate hikes in his remarks at a press conference.
You may remember what happened next: Stocks tumbled, with investors concerned not just that higher interest rates would discourage consumers from buying homes and businesses from borrowing to invest, but that the Fed was blasé about signs of global economic weakness and appeared intent to march on with higher rates, even if they became inappropriate given economic conditions. Treasury Secretary Steven Mnuchin had to call major bank CEOs from the pool in Cabo San Lucas and reassure Americans that the Treasury Department stood prepared to ensure the soundness of the financial system.
Nobody was angrier about the rate hikes than President Trump, who raged about them on Twitter and elsewhere. And then, he appeared to win the argument: Fed officials quickly moved to resolve their apparent miscommunication with the markets, reassuring investors they would shift interest-rate policy if economic conditions changed. And at subsequent meetings, they changed their guidance to indicate they likely would not raise interest rates at all in 2019.
Since then, Trump has pushed his luck. He declared his intention to name Steve Moore and Herman Cain to the Fed board. These men — both of whom have now withdrawn themselves from consideration — lacked traditional qualifications to join the Fed but share a newfound ideological commitment to the president’s easy-money monetary-policy views. Moore, when he’s not calling for the president to fire Powell (whom Trump named to the job less than two years ago) has been calling for steep cuts in interest rates. So has the president, who declared before Wednesday’s Fed meeting that the bank ought to cut interest rates by a full point (normally, it moves them by just a quarter-point at a time) and also restart its crisis-era quantitative-easing practice of buying long-term bonds to push down interest rates.
The Fed ignored the president’s demand, keeping rates unchanged. While some commentators have pointed to below-target inflation as a reason the Fed could afford to cut rates, Powell declared Wednesday that the factors holding inflation below the Fed’s 2 percent goal appear to be “transitory,” citing, for example, a onetime change in the way apparel prices are calculated. He said the Fed would continue to watch inflation but declined to say that any particular future inflation signals could justify a rate cut.
I think these recent events help us understand what happened in December, and provide an indication that Federal Reserve independence has not been undermined as much as it appeared to have been at the time.
The reason the Fed flinched then and not now is that the stock market tanked then, but not now. Among the factors Fed officials often cite to justify rate decisions, along with economic data, are “financial conditions.” Financial conditions include stock prices — falling prices may be a sign of expected economic weakness, and can give the Fed reason to consider easier policy, including lower rates, or at least the cessation of rate hikes. When the Fed so upset markets in December, it caused financial conditions to change; that helped the Fed understand more rate hikes were not warranted in the near term.
I should note that being reactive to the market like this is not necessarily a bad thing. The markets fell in December because they were under the impression that the Fed was about to make bad policy. To some extent, this was a miscommunication: It seems clear from Powell’s later comments that he had not meant to convey inflexibility in the face of changing economic conditions, and that the Fed was always prepared to cut rates or stop reducing its bondholdings if the economy softened enough to warrant those changes. Clearing up that misunderstanding didn’t mean shifting the underlying policy the Fed was making. But the Fed’s shift on 2019 interest-rate policy — ceasing its program of rate hikes — has been real, and warranted, given the financial market reaction.
The markets are not demanding the sort of steep rate cut the president is now demanding, and so unlike in December, the Fed is free to ignore what he wants. Republicans in Congress surely share the president’s desire to avoid a recession, but they’re also wary of a politicized Fed, which Trump surely would not hesitate to continue to pressure to cut rates even if that meant spiking inflation. And unlike with the Supreme Court, there’s no need to confirm anybody at all to the Fed board’s vacant seats in order to achieve conservative policy outcomes.
So when the president rants and raves and tweets about the Fed, he now appears to do so in a void. He has not lost the power he appeared to have over the Fed in December. He never had that power. The stock market did.