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The Asset Class: Ruen Naidu · Strictly Business

• 0:00
  You're listening to Strictly Business Podcast with Lindsay Williams.
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  Controversy has been swirling around the Fed for quite a while now,
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  with a rather public spat between the US President and the Chair of the US Federal
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  Reserve.
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  So why is the Fed story so important as Jerome Powell departs and Kevin Walsh
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  takes the chair?
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  With me is Ruan Naidoo, Portfolio Manager at 91 in Cape Town.
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  Ruan, there are so many layers to this terribly interesting story.
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  But I won't get distracted.
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  We've got to focus on why it is so important.
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  Sure, Lindsay.
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  This story, it's really not just about who's going to become the next Fed chair.
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  You know, it's really about whether the Fed can remain as an independent
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  institution in the face of
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  unusually direct political pressure.
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  And this matters because the Fed's credibility,
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  it depends on the market believing that it is independent.
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  And it is making interest rate decisions that are for economic reasons and not for
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  political ones.
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  OK, now let's get back to what I hinted at in my introduction, the Trump pressure on
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  Jerome Powell.
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  Why is he doing it?
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  I mean, Jerome Powell is a Trump appointee, I think.
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  That is totally correct.
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  The issue at hand here is that Trump, as president of the United States,
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  wants lower interest rates.
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  It is his instinct as a real estate...
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  developer, but also it's important for goosing up the market and economic growth.
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  So his criticism has been that the Powell
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  Fed has been too slow to cut interest rates and has been focusing too much on
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  near-term inflation
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  risks.
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  And what makes this particular episode quite unusual is that the pressure has
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  gone beyond simple
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  criticism.
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  It's actually gone into legal channels.
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  And this includes
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  a recent DOJ subpoena that has been linked to building renovation cost overruns that
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  the Fed has embarked on.
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  Yes, I remember that famous picture as he walked around the building site, I think
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  it was with Jerome Powell,
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  and he pulled out something from his suit pocket and it showed in his eyes anyway
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  how much had been spent.
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  But anyway, again, I've been distracted.
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  I said I wouldn't be.
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  Why does the Fed independence matter so much?
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  I mean, we see the Fed.
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  And we see their meetings.
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  We see the chair coming up and saying interest rates are going to be this after
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  this meeting.
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  And this is the reason why.
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  And then you don't really hear from them that much.
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  And government hasn't in the past got involved.
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  That independence, I think, is being challenged now.
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  Yes.
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  You know, if monetary policy becomes far too political,
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  there's just a natural temptation to keep policy rates low for too long.
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  you know, in the short run.
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  This can support growth, but it risks high inflation over the medium term.
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  It also creates financial imbalances.
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  And all of this ultimately weakens confidence within the bond market.
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  So independence actually gives the Fed the space to take difficult,
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  longer-term decisions and do so even when they are politically uncomfortable.
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  Now, this brings us to the incoming Fed chair, a chap called...
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  Kevin Walsh.
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  He was born in 1970.
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  He's a financier.
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  He was nominated by Trump. But he's made it clear.
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  I think he said something like, I'm not going to be Trump's hand puppet, something
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  like that.
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  But why did Trump choose him in the first place?
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  Yes, he did testify to Congress that he would not be a sock puppet, I believe the
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  words were.
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  So Walsh actually meets, you know, three criteria that are crucial for Trump.
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  So the first and most important, he shows a greater inclination towards lower policy
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  rates than Powell did.
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  And so that clearly aligns him with Trump's preference for easier monetary
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  policy.
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  Then secondly, he brings sufficient institutional credibility.
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  So he's accepted by the markets.
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  He was formerly a Fed governor and he served during the great financial crisis
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  and actually played a crucial role in that
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  episode in terms of stabilizing financial markets and the banking system.
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  So in that sense, the markets are not necessarily going to see him as the Trump
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  sock puppet,
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  but actually someone with experience.
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  And then finally, there's the reform angle.
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  So Walsh has been very critical of how the Fed operates over the years since he's
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  departed from the Fed,
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  particularly around how they communicate, their forward guidance, and their balance
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  sheet operations.
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  So that likely appeals to Trump.
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  because it positions Walsh as someone willing to challenge that internal culture
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  at the Fed.
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  So for markets, this makes him not just a dovish pick,
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  but he's a market-credible reform candidate and someone that the
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  administration may expect to be more
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  accommodative, but he also has the background and institutional credibility
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  to avoid a
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  sudden loss of confidence in the Fed.
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  Do we know if he's ever opposed a Fed decision?
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  I mean, he's on the board of governors and sometimes there's a split in the vote.
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  Has he ever opposed it?
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  Oh, he certainly has.
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  And this is the key reason why he departed from the Fed in his original term.
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  He left his Fed earlier than his term.
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  And the reason was he was opposed to the balance sheet operations of the Fed,
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  the quantitative easing programs that the Fed embarked on.
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  And he continues to retain that displeasure with a large balance sheet of
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  the Fed.
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  So.
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  While at the Fed, he was opposed to them and he continued to oppose that balance
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  sheet operations after he departed as well.
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  Right.
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  Now the markets, the markets have been on tenterhooks waiting for the new appointee.
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  And now we know who it is.
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  How have they reacted?
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  So the market response has not been a straightforward Kevin Walsh equals red
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  cuts story.
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  So the market had previously.
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  had some pricing in the front end of the curve that suggested an expectation of
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  rate cuts.
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  But that has since shifted towards a Fed with on-hold buyers.
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  And if anything, there's a small probability of a hike in the tail end of
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  the cycle.
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  So that suggests that investors either see Walsh as credible,
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  or they see him as someone who is not going to be able to deliver easier policy
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  on Trump's
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  demand.
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  So a Walsh-led Fed, it probably means a shift in emphasis and not a real immediate
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  policy break.
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  He might change the outlook for forward guidance.
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  And over the longer term, he might adjust the balance sheet.
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  But the market is not really pricing those factors in, because what the market is
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  focused on is that
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  Kevin Walsh will have one vote out of 12 votes within the committee.
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  So the focus on what the other 11 Committee members have been saying,
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  take some sort of precedence over Walsh.
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  When a new Fed chair enters the seat,
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  the first thing he actually has to do is prove his inflation fighting credentials.
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  And he also has to seek some way of building consensus within the committee.
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  So the main risk to my mind is that once Walsh enters the seat,
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  he proves less dovish than markets currently expect.
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  and Trump currently expects.
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  And that could ultimately put some upward pressure on the front end of the yield
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  curve of the United States.
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  It's interesting, isn't it?
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  Because if that situation plays out, the one you've just spoken of, and he's not as
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  dovish, and Mr.
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  Trump doesn't like him, then he could easily turn on Trump, that is, as he
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  turned on Powell.
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  Totally.
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  An important consideration in this regard is that Jerome Paul has decided
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  to stay longer than the end of his chairmanship term.
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  So Fed governors have 14-year terms, but the chair has four-year terms.
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  What this means is that Trump will be forced to appoint Walsh for a 14-year
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  term.
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  Had Powell decided to leave early, Trump would have been able to replace the
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  remaining piece of
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  Powell's term, which is about two years, and put Kevin in that seat for a two-year
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  period,
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  which would keep him on a short leash.
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  This longer 14-year term that Kevin Walsh will be stepping into gives him some sort
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  of
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  insulation against that political pressure to cut rates now to keep your job.
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  Ruan, it's a fascinating story and it will continue to be so, I think.
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  Thank you very much for describing it.
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  Ruan Naidoo is a portfolio manager at 91 in Cape Town.
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  The views and opinions expressed in these podcasts are those of Lindsay Williams and
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  various contributors and do not reflect the policy,
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  position or opinion of any other agency, organisation,
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  employer or company associated with StrictlyBusinessPodcast.com.
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  Assumptions made on the analyses are not reflective of the position of any other
• 9:39
  entity other than the speaker or the author.
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  And since we are critically thinking human beings, these views are always subject to
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  change, revision, and revision.
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  and rethinking at any time.
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  Please do not hold us to them in perpetuity.