New Powell, Similar Doctrine

Adam Whitehead profile picture
Adam Whitehead


  • In the closed system of the US domestic economy, Powell Doctrine is theoretically robust.
  • Powell Doctrine thinks domestically and acts gradually.
  • Powell Doctrine may tend towards Volcker Doctrine over time.
  • Raphael Bostic signals that global trade war threats have lowered the neutral rate to the current level at which the normalization should be paused.
  • The data dependent Fed has become a hostage of its diverging dual mandate drivers.

The last report observed Fed Chairman Powell assuming a doctrinaire mantle of Communicator in Chief of monetary policy for the FOMC. Chairman “Jay” Powell Doctrine shows much commonality with that of former White House Communicator in Chief General Colin Powell Doctrine. The erection of doctrinaire boundaries around a policy has the tendency to create rigidity. This corresponding lack of flexibility undermines the response to changes in the environment. Chairman Powell has tried to build in some flexibility by being data dependent. Unfortunately for him, something called the Fed’s dual mandate may compromise this flexibility.

There is a national security interest in Chairman Powell Doctrine, in the form of protecting the US Dollar’s global reserve status. This protection enhances the ability of America to finance its expanding fiscal deficit; in a hostile global economy where President Trump views economic policy as synonymous with national security policy.

Recent signals out of the White House suggest that there is greater concern over the sustainability of the economy, creeping into national security thinking, as the global headwinds from trade tensions build. The President recently called for further corporate tax cuts, but these are now incremental rather than the original deficit boosting quantum leap. His master’s voice Larry Kudlow also wrapped the latest tax cutting rhetoric, in an entreaty to the Fed, to be gradual with its tighter monetary policy response going forward.

President Trump’s view is however right on the money, if President Xi Jinping’s recent commentary and behavior are good guides. President Xi clearly linked the current economic tensions between the two nations to national security concerns, when he aggressively told Secretary Mattis that China will not yield “one inch” of its territory.

Since China claims most of the maritime territory in South East Asia, the bilateral trade tensions are just code for something much more strategic. China does not yet physically control the territory that it will not yield “one inch” of. First therefore, a Chinese conquest by economic and political means must occur to make good on President Xi’s message. America is highly unlikely to sit by and watch, or even negotiate away its position, as China projects.

China and America have entered into a resource sapping Cold War that will test the longevity of each nation’s economic resources and organizational capabilities. America has fought and won a Cold War before, whilst China has been preparing for this one for some time. It makes for compelling viewing…… and policy making!

Chairman Powell is also simplifying Fed policy making to become less intellectual and more practically data dependent. This “clear and obtainable” objective has the benefit of also giving the Fed the flexibility required to adapt to new economic and political conditions. Objectives have thus been simplified and clarified in a manner consistent with the Fed’s dual mandate guidelines. The current problem is coming from the fact that the incoming data set these two guidelines in conflict with each other in terms of monetary policy execution.

(Source: Gallup)

The Chairman’s communication style is aimed at public understanding and hence garnering its support. As a backdrop to public support, it should be noted that Americans’ satisfaction (although egregiously partisan and disengaged in general) is actually as good as it has been for a long time. It is actually better than it was under both Presidents W. Bush and Obama. Powell Doctrine may thus find a receptive audience.

Overwhelming force, as per General Powell Doctrine, is being applied by Chairman Powell in a gradual fashion rather than with singular “Shock and Awe”. The Fed Chairman is however not averse to the negative global “shock and awe” impact, that his resolute commitment to gradually higher US interest rates is having in the global economy.

The results of the latest Fed stress tests will no doubt have confirmed the Chairman’s belief in the application of gradual overwhelming force. The results of the tests showed that, whilst the US banks would take a large hit in a worst-case scenario event, they would still have a stronger capital position to withstand it than in 2008.

One hopes that the Fed has noted that the banks swiftly undermined their alleged fundamental capital base strength, by responding to the stress test results with massive cash payouts to their executives and shareholders through higher dividends. The financial incentives for Wall Street to bet the house have thus been reinforced by the Fed once again.

Using General Powell’s yardstick therefore, Chairman Powell has the essential ingredients for success. Going forward, it will be interesting to see if his FOMC colleagues toe this new line of Powell Doctrine. A collegiate consensus is still required to execute, as General Powell would agree.

Whilst turning up his own microphone, at the last FOMC meeting, Chairman Powell effectively turned down/off those of his colleagues by de-emphasizing the role of guidance (except his own!) as the neutral rate of interest comes into view. Recent economic data shows that the neutral rate is here. In practice does this mean that his colleagues should remain silent, whilst Chairman Powell becomes their spokesman going forward? Unlikely, but he may chance his hand.

Retiring New York Fed President Bill Dudley intends to go out on a Hawkish note. His latest valedictorian remarks followed the new Powell Doctrine to raise real US interest rates. Whilst paying lip service to the new lower neutral rate, Dudley then nudged headline interest rates higher by opining that they may now need to be pushed slightly above neutral.

Whilst avoiding challenging the Powell Doctrine, to finance the rising fiscal deficit with global capital flows at attractive real yields, Dudley warned that this strategy could become unsustainable by 2020. His warning however fell well short of embracing the globalist spirit that he once embraced and now is challenged by President Trump and the Fed’s monetary policy stance.

Dudley does not believe that the Fed is to blame for the turmoil in emerging markets. The signal is that there is more pain to come, in the global economy, as the Fed redirects global liquidity to finance the widening US Fiscal deficit.

Dallas Fed President Robert Kaplan as a non-voting member, seems to feel less constrained by Powell Doctrine. In recent commentary, he reiterated his baseline of one more rate increase this year. He did however admit, that he could be persuaded to agree to the consensus for one more rate hike if the data makes a strong enough case for it. In spirit, he therefore remains compliant with the data dependent principal of Powell Doctrine.

Kaplan did however sketch out an interesting grey area in his own thinking about globalism and Powell Doctrine. Embracing the globalist status quo, that is currently threatened by President Trump, Kaplan opined that trade is an opportunity and not a threat. He then qualified his position more specifically in a global context. He sees NAFTA as a key trade system that should be preserved, whilst he actively supports conflict with China. In his view the Chinese steal western technology through joint ventures, which they then re-export through another gateway back to the global economy.

On his first outing, post Powell Doctrine epiphany, New York Fed President John Williams chose to avoid extemporizing on his pet inflation target overshooting project. Instead, he chose to opine that the economy is in “great shape”. His new pet project is the reform of bank culture to make sure that Wall Street does not squander this legacy that the Fed has created since the Global Financial Crisis. Williams obviously missed the green light that the recent Fed stress tests gave to the old egregious Wall Street incentives and culture!

(Source: Atlanta Fed)

Atlanta Fed President Raphael Bostic shows a schizophrenic form of compliance with Powell Doctrine. On the domestic economic front, he is fully compliant, as his latest speech entitled “The Path to Resilience” shows. Loosely translated this could be renamed a “The Gradual Path to the Neutral Rate”.

On the global front however, Bostic is less compliant. He recently hinted at a potential divergence, from the accepted gradual pathway to continued higher interest rates, based on global developments. This global view is increasingly in conflict with his domestic view, setting up an interesting tipping point. He may already have reached that tipping point.

In a following interview, after his “The Gradual Path to the Neutral Rate” speech, Bostic averred that the deteriorating global trade picture had made the job of getting back to neutral even harder. He emphasized that the Fed is trying to sustain economic growth. Put against the deteriorating global trade picture, sustainability no longer means curbing financial excess with higher interest rates. Now on the contrary, sustainability means economic stimulus. Trade wars have thus lowered the neutral rate, possibly to the level already prevailing today. Bostic may therefore just have signaled “The Gradual Arrival at the Neutral Rate”.

It would appear that Bostic believes that the Fed is very close to the neutral rate and that given the recent global headwinds, he will vote to pause the interest rate hiking cycle very soon. In his latest developing conflicted commentary, he related that “I (Bostic) began the year with a decided upside tilt to my risk profile for growth, reflecting business optimism following the passage of tax reform’’ and “that optimism has almost completely faded among my contacts, replaced by concerns about trade policy and tariffs. Perceived uncertainty has risen markedly.’’

Of the neutral rate’s proximity, Bostic opined that “We are getting close to the lower part of most plausible estimates of the neutral rate’’ and also that “a key policy question going forward is how many more rate increases are required to complete the transition to a policy stance that is neither accommodative nor restrictive.’’ Bostic is going to have this debate out in the open and will not give Chairman Powell carte blanche to be his spokesman.

Bostic’s schizophrenia is a good cypher for the inherent risk in Powell Doctrine. In a closed system where the US economy is self-sustaining, the gradual tightening of monetary policy can engineer a soft landing at the neutral rate. The diverging drivers of the Fed’s dual mandate can be contained within strict domestic boundaries. The flexibility of being data dependent, even when the data diverges, can be managed more effectively. In a globally connected world, this flexibility is significantly undermined.

Minnesota Fed President Neel Kashkari’s commentary signals that he does not subscribe to Powell Doctrine and will continue to resist it in the public domain. He still sees no signs of economic overheating and noted that the Fed is still surprised by the lack of wage inflation. Rather than kill the expansion prematurely, he would rather not raise interest rates further. Kashkari also doubts the sustainability and lifespan of the economic strength created by the recent fiscal stimulus.

Boston Federal Reserve President Eric Rosengren conforms to the traditional Fed collegiate consensus building. This traditional M.O. allows for independent thought and guidance. He will therefore only conform with Powell Doctrine, when it runs parallel to these Fed traditions. On the subject of tight labour markets and capacity constraints, he still continues to favour further interest rate increases.

St Louis Fed President James Bullard is too much of an independently minded communicator to embrace Powell Doctrine. In fact, he may ultimately become an active critic, in addition to dissenting FOMC voter when his time comes. His latest warnings contained the signs of this new role. In his own words: “there is a risk that we’ll go too far, too fast as a committee.” Anticipating calls for the Fed to accelerate its interest rate hiking efforts, in response to a temporary surge in Q2 GDP, Bullard advised against succumbing to this temptation.

In the global economy, Powell Doctrine is a tractor beam sucking global liquidity into the US economy. This liquidity can finance the expanded US fiscal deficit and sustain the domestic economic stimulus, even at a higher real rate of interest cost to the economy. Economic sustainability thus relies upon gradually rising interest rates to beget the global liquidity to enable continued growth.

The current tendency is therefore for the Fed to keep gradually tightening to sustain its domestic Goldilocks conditions. There is also a risk that rising domestic liquidity requires tighter monetary policy, to address inflation risk, that will then serve as a further stimulus by sucking in more global liquidity. A breaking point would then be reached, at which the global economy becomes exhausted in supplying further liquidity to the American economy. At this point, global recession will combine with a US recession to call for a concerted global expansion in monetary policy. Raphael Bostic’s afore-mentioned schizophrenic commentary reflects the benign domestic and unstable global environment growing in tandem. He is the classic two-handed economist that President Truman scorned.

Chairman Powell by comparison, is not an economist and has only got one hand. Unnervingly for the global economy, he waved it recently at the ECB’s summer forum in Portugal. Facing a potentially hostile audience, he reiterated that he will press on with his gradual interest rate hiking mission. Powell Doctrine thus continues to drive the US domestic and global economies towards the dangerous tipping point described above.

(Source: Federal Reserve)

Chairman Powell chose a speech at the ECB’s central forum at Sintra in Portugal, to lower the probability estimate of hitting the dangerous tipping point any time soon. He did this by clearly contrasting the difference between Powell Doctrine and Volcker Doctrine. Volcker Doctrine if repeated, would see the global economy arrive swiftly at the dangerous tipping point. In his speech Powell noted that, since the days of Volcker Doctrine, global central banks and globalization have done a very good job at containing inflation expectations. He therefore does not expect that Powell Doctrine will be a rerun of Volcker Doctrine. The inference is that interest rates will thus not have to spike, with dangerous economic impact, as they did under Volcker.

Powell Doctrine is gradual compared to the blunt force of Volcker Doctrine. This does not mean that Powell Doctrine will not converge on Volcker Doctrine over a longer period of time however. The speech was far from a trip down economic memory lane, as a means to assuage fearful global peers. The statement of FOMC intentions and capabilities was clear, whilst the implied threat was extended over time rather than front-loaded.

Chairman Powell unapologetically told his audience that his policy is still driven by the America First prime directive. This prime directive plays out through his legally mandated terms of reference to execute policy through the growth and inflation mandates.

(Source: Seeking Alpha)

The last report framed the dangerous tipping point in relation to Chairman Powell thinking and acting domestically, rather than including some global thinking and acting in his policy making. For the record, Chairman Powell is now still thinking domestically but acting gradually.

Some analysts have already discerned signs of the global tipping point, in the latest trade data. US companies are boosting their exports now, before the anticipated trade backlash occurs.

There is also a domestic tipping point looming for Chairman Powell. The Fed will hit its own neutral rate target measurement soon. Indeed, the latest data suggest that it has arrived. The Q1/2018 Core PCE is at 2.3% having fallen from 2.5% in Q4/2017. The Q1/2018 GDP Price Index just moved up to 2.2% from 1.9% in the previous corner. These measures of inflation suggest that the Fed is already at neutral.

The domestic problem is that American inflation expectations have still not caught up with the present. In addition, measures of real aggregate economic growth show the beginnings of retrenchment. The Fed is thus at a point when it should be saying mission accomplished, even though American consumption is saying that this is no longer true. Going forward, if American inflation expectations remain resiliently disinflationary the Fed risks being too far ahead of the inflation mandate curve. In fact, the Fed may be on the wrong curve! Calls for a switch to the growth mandate curve will then rise.

There has been talk among some Fed presidents about allowing inflation to overshoot target, without raising interest rates. This talk clearly has basis in the observation that aggregate demand is not as strong as the Fed would like, to fully justify a tightening of monetary policy. The Fed is faced with a dilemma from its two mandates.

To try and mitigate the risk to himself, the Chairman has also sought to reform Fed guidance. This reform is intended to make the guidance more opaque and also to give his press conference speeches the priority, in framing perceptions of the Fed, over that of his colleagues. He thus concentrates flexibility and decision making in his hands. The risk is that he does not use the power responsibly.

It is no surprise to see Neel Kashkari exposing the fault lines within the Fed over its potentially conflicting diverging mandate agendas. He characterizes this as "a very honest assessment of the confusion". Onto this candid admission, he also projects his own view that the FOMC should pause when it hits the neutral rate. He judges the pause to be appropriate because thus far, inflation is not confirming the move to tighten monetary policy further.

The last report ended on the sobering note, of the discussion of the light-touch being applied by the Fed to banking counterparty risk regulation. This is part of the process of rolling back post-Crisis tight regulation in tandem with post-Crisis easy monetary policy. President Trump’s new appointee FDIC Chairman Jelena McWilliams recently joined the fanfare of trumpeters for more light-touch regulation. She announced that she will review bank ratings, living wills and Basel compliance. Clearly, there is no intention and capability to undertake this review with a view to tightening regulations. The thumbs up from the Fed’s recent stress tests can only have strengthened her resolve to roll back regulation. As President Trump isolates America, its banking system is starting to decouple from the global governance framework. All this is occurring just as Chairman Powell sucks capital into said lightly regulated US banking system with rising real interest rates.

(Source: Boston Fed)

Fortunately, Boston Federal Reserve President Eric Rosengren has got his eyes on the deteriorating financial stability environment, that is being undermined further by the rolling back of regulations. He puts this rolling back of regulation into an ethical context, in which the costs of a financial crisis are born disproportionately by those who cannot afford them. He has stopped short of saying that QE, as a response to the financial crisis, actually rewards those who created the crisis in the first place. QE and its beneficiaries still remains a contentious matter that is a little too close to home for Rosengren’s and the Fed’s comfort.

This time around however, Rosengren warns the crisis creators to take out some insurance now. His implied threat is that the Fed will not bail them out next time. His response called for a rise in bank capital adequacy levels, in a pro-cyclical manner, whilst the economy still has economic strength. It remains to be seen if his call will be met with any affirmative action.

Framing the regulatory reform of Chairman Powell as “unethical” is a strong call by Rosengren. He needs to be careful not to get hung by also getting QE tarnished with this “unethical” halo. After all, the Fed will have to deal with the next crisis which it is now helping to create by raising interest rates and rolling back regulations simultaneously. Rosengren’s righteous zeal is commendable, but unworkable in practice. Powell Doctrine maybe unethical, but Fed Presidents who live in glass houses should not throw stones either. In response, Powell should tread very carefully in relation to his zeal for rolling back regulations without charging the banks a capital haircut for boosting their bottom lines.

This article was written by

Adam Whitehead profile picture
Over thirty years of taking the volatility out of uncertainty, by taking the uncertainty out of volatility, for proprietary trading desks, commodity trading advisors, sovereign wealth funds and private offices.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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