Cycle will prove Fed chair's worth

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US Federal Reserve

A turn in the cycle will prove the new Federal Reserve's worth and mettle, writes Eric Winograd, AllianceBernstein's senior economist based in the United States.

Jerome Powell, President Trump’s pick to lead the US Federal Reserve, is likely to continue the central bank’s gradual retreat from conventional policy.

But the test for a Powell-led Fed will come when the economic cycle turns.

Governor Powell has been a member of the Federal Open Markets Committed since 2012.

He helped to design the programs that the Fed has put in place to reduce the balance sheet and he’s been a vocal proponent of the plan to raise interest rates gradually.

On this basis, there’s no reason to expect a dramatic change in policy with his appointment, and the market has taken comfort from that.

Worried about bubbles

But there are a couple of ways in which he differs from the outgoing Chair, Janet Yellen, and many of his earlier predecessors.

These differences may prove significant for the way he approaches his job, especially when the economy begins to slow.

For example, he seems a little more concerned than Chair Yellen about the idea that bubbles could emerge that would be disruptive for the economy.

He may therefore be a little quicker than she would have been to respond to signs that financial markets are getting over their skis.

His background is also different from that of recent Fed chairs.

Lawyer, not economist

He’s no academic PhD economist but a lawyer by training and much of his professional experience has been in private equity, although he has also worked in the Treasury Department.

That makes his appointment a little bit unusual.

That said, he’s been on the board for the last five years, so he’s certainly well-versed and experienced in monetary economics.

On balance, I don’t think that the markets should be overly concerned that he doesn’t have a conventional academic background.

To some extent, however, the markets may be overlooking the fact that it’s not just the chairman that’s going to change.

More appointments

There are several vacancies on the Board of Governors, and there are likely to be more. President Trump will need to make more appointments to keep the board functioning.

Under normal circumstances, or at least recently, the members of the Board of Governors have not been publicly prominent, because the chair of the committee has had such a dominant voice.

But because Governor Powell, and presumably future Chair Powell, doesn’t have the same sort of academic grounding, he may find himself more reliant on other members of the Committee.

For this reason, the appointment of a new Vice Chair, or the appointment of other members of the Board of Governors, will take on increased importance.

And the clock is ticking, because, if we assume that Chair Yellen leaves the Fed when her term expires in early February, at least one other new member of the Board will need to be appointed by that time to keep the Committee functioning.

It takes a crisis

The appointment of Governor Powell as Chair doesn’t imply any change in outlook for the near-term, in my view.

He is likely to pursue policy continuity, which suggests one more rate hike this year and two additional rate hikes in the first half of next year.

Investors need to remember, however, that Fed chairs don’t prove their worth in normal circumstances.

In normal circumstances, whether you’re a PhD economist, whether you’re an experienced market professional, it doesn’t matter that much.

 The job of a Fed Chair is to be a faithful steward and allow the economy to play itself out, to move policy gradually.

That’s all well and good, but Fed Chairs prove their mettle and their worth in times of crisis and at turning points in the cycle.

It isn’t until we get to one of those points that the US and the rest of the world will know whether Governor Powell’s appointment was a good one or not.