New Generation Takes Fed Leadership
The end of an era approaches. As you read this, a new Federal Reserve Chairman will have been sworn in, taking the helm from Jerome Powell, and the impact of this transition could be significant.
Jerome Powell has served as Chairman at the Fed since 2018, and as a Board member since 2012. To say this has been an impactful period is an understatement. Powell’s Fed inherited the legacy of the Great Financial Crisis of 2008, dealt with the COVID crisis in the middle and finished with the affordability crisis of the past few years.
During Powell’s eight years as Chair at the Fed, the Federal debt has nearly doubled, from $21 trillion to roughly $40 trillion. In addition, despite initial efforts otherwise, the Fed’s balance sheet, which is a measure of the financial assets held at the Fed, and by osmosis the supply of money in the economy, also nearly doubled.
Reflecting these dramatic statistics, under Powell’s Chairmanship the U.S. economy experienced a greater “financialization” of economic outcomes. During each of the crisis mentioned prior, the Fed’s response has been to increase the money supply and lower interest rates in support of financial markets. On the positive side of the ledger during the past eight years, the U.S. economy experienced no deep recessions (a brief recession occurred during COVID), and the price of stocks as indicated by stock prices (S&P 500), increased in value roughly 180% during his term (source: S&P).
Chair Powell unfortunately also allowed the Fed to be drawn into the political realm with initiatives and policies attempting to address ESG (Environment, Social, Governance) issues in ways investors like me found concerning. In my opinion however, when future economists look back at this time, the negative legacy of these policy responses, in particular inflation and a growing inequality, will likely be the dominant reflection.
In addition, in recent years Fed policy under Jerome Powell has not reflected President Trump’s economic objectives, leading the President to turn is ire on Powell, which from my perception has Chair Powell finishing his term in a damaged and somewhat feckless state. Said simply, it’s time for a change, and change may be what we get.
The incoming Fed Chairman, Kevin Warsh was confirmed by the Senate on May 13th, and in current Washington fashion, the process was a bit more contentious than typical. Like many Trump administration appointees, Mr. Warsh brings an approach and philosophy to the Fed marking a material change from recent precedents. It’ll be important to understand the underlying philosophy driving Fed policy under Warsh, while at the same time appreciating the headwinds and entrenched economic realities likely to make the path to any real change difficult and bumpy.
The philosophical economic agenda under Kevin Warsh is likely to be an attempt to “de-financialize” the American economy. This de-financialization will be an attempt to address the wealth disparity between lower income, often younger Americans, and older, higher income Americans which has grown to treacherous levels. A central contributing factor in this trend is the challenge presented by asset prices.
Asset prices, and asset price growth, can be a direct consequence of Fed policy regarding the size of the overall money supply. As the Fed has induced the growth of the money supply over the past nearly two decades owners of assets have enjoyed increased wealth through higher asset prices. This prosperity, however, has not necessarily resulted in increased the productive capacity and the productivity gains typically benefiting younger Americans. In addition, higher asset prices have made it more difficult for these same young, new investors to come into the asset markets (stocks and real estate).
From the analysis I’ve read, to address these challenges a Warsh Fed may attempt to reduce the size of the Fed’s balance sheet in effort to “decentralize” the size money supply, while at the same time altering banking regulations to ultimately incent more private sector lending. While the result of this policy twist would not necessarily result in a contraction of the money supply, it may drive capital creation away from the central bank and towards the real economy, which also may mean away from financial assets. The hope being, capital allocated by the private economy instead of simply the financial sector could ignite productivity gains and innovation, creating opportunity and growth for a wider swath of Americans.
The primary headwind to any Fed monetary policy, however, will remain the massive borrowing needs of the Federal government. The President and Secretary of the Treasury have made it clear they want lower interest rates, and how the Fed will manage reduced interest rates as well as a stagnant or shrinking Fed balance sheet and funding the government as well as banking reregulation at the same time will be quite a balancing act. Investors would be wise to be wise to be skeptical.
One last brief note. Kevin Warsh is 56, which makes him Gen-X like me. We Xr’s bring a distinctly different worldview to the conversation than our Boomer friends who have held the reins of government for decades. We have less trust in institutions and more faith in markets. For me, it’ll be fascinating to see the X’r value system finally injected into economic policy. Let’s see where this goes.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
