Watch the Fed’s New Guard, Not the Old


by Jim Rickards, Daily Reckoning:

Expert consensus was almost unanimous that the Fed had sent a hawkish message after its September meeting. A December rate hike was “still on the table.”

But with or without a December rate hike, the experts were clear that the Fed was still on a path to tighten rates at a sustained tempo.

The view was expressed in all of the major news outlets.

Markets got the message. The dollar rallied, the euro declined, gold traded down and interest rates ticked up. That’s exactly what you would expect if the Fed gave hawkish signals based on continued moderate growth.

There was only one thing wrong with this story, as I explained at the time: everything.

And Friday’s exceptionally weak core PCE inflation data only drives home the point.

Friday’s data practically guarantee the Fed will not raise rates in December. The economy is not strong and the Fed may not raise rates again until well into 2018 — if then.

How can so much time, effort and talent be devoted to such a simple task and still get the wrong result? How could they get it so wrong?

The answer is that the so-called experts are using the wrong model of Fed behavior. As I’ve said many times, if you have the wrong model, you will get the wrong result every time. This happened again following the September Fed meeting and Janet Yellen’s subsequent press conference.

So what’s wrong with the mainstream model?

Its major shortcoming is that it pays attention to the Fed projections of growth and interest rates. These are the so-called “dots” (because they’re presented as a set of dots on a chart showing dates and rates.) All of the members of the board of governors and the regional reserve bank presidents are invited to provide their own dots.

The media glom onto the dots, compute an average of the dots and then treat the average as a consensus of Fed opinion. They project Fed policy based on this consensus. Markets react to the consensus estimate.

Here’s the problem. The dots are a joke. No one in the Fed headquarters in Washington takes them seriously. Starting the “dots” was an attempt at transparency by Ben Bernanke. The Fed can’t seem to get rid of them.

The media love them. But they are a joke. Pay no attention to them.

There’s a much more important Fed story that hasn’t gotten much media attention. But this story, not the Fed’s “dots,” could have a dramatic impact on interest rates going forward.

I’m talking about a changing of the guard that’s taking place at the Fed. I’ve mentioned it before, but I want to reinforce the point…

To review, the Federal Reserve’s Board of Governors is made up of seven appointees. That means that they can make a majority decision with four votes. The real power within the Fed is found on this seven-member Board of Governors.

Here’s the remarkable part:

As of last month, four of the seven Fed board seats are now vacant.

Trump inherited two board vacancies from Obama. Then in April, Federal Reserve Governor Daniel Tarullo resigned. His departure gave Donald Trump a third appointment.

Then on Sept. 6, Fed Vice Chairman Stanley Fischer suddenly and unexpectedly resigned. His resignation marked the fourth vacancy.

That means Donald Trump will be able to shape the Fed’s majority in a remarkable fashion. Remarkably, he now has the opportunity to appoint a higher percentage of the Board of Governors of the Federal Reserve system at one time than any president since Woodrow Wilson.

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