Reign of the Fed threatened by politics

Reign of the Fed threatened by politics
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The FORM Act of 2015 seeks to rein in the Federal Reserve with audits, oversight, and policy rules. Whether or not it passes, American political trends are pointing to increased scrutiny of the Fed going forward and by extension the extraordinarily accommodative Fed policies that have lifted markets since the Financial Crisis of 2008.

The Fed Oversight Reform and Modernization (FORM) Act of 2015, or H.R.3189, filed in July of 2015, just quietly passed the House of Representatives on a party line vote last week on November 19.  

The bill is not expected to pass the Senate, and the US President has promised a veto, while the current Chairman of the Federal Reserve, Janet Yellen decried the Act a “grave danger.”

So what about the FORM Act elicits such a stern rebuke besides the obvious partisanism?

The FORM Act amends the original Federal Reserve Act to, among other things, subject the Fed to an audit performed by the Government Accountability Office (GAO) upon the monetary policy conduct of the Board of Governors and the Federal Open Market Committee (FOMC).

While independent audit portions of H.R.3189 grab headlines and undoubtedly carry favor with Fed critics, it is the policy requirements and oversight that have the central bankers most concerned.  

The Act requires the Fed to establish a formula, a Directive Policy Rule, including variables such as inflation and employment, by which it will determine policy decisions such as interest rate levels.  

Any changes that deviate from the established formula would result in congressional testimony by the Fed Chair to explain noncompliance.  Moreover, the FORM Act restricts the Fed’s emergency lending powers, a move Yellen says will limit the Fed’s ability to act in a financial crisis.

If the Act were to pass, the Fed Chair believes the legislative limitations to emergency powers would “likely lead to an increase in inflation fears and market interest rates, a diminished status of the dollar in global financial markets, and reduced economic and financial stability.”  

Being that the Act is not expected to pass, the public push back by the Chairman Yellen and President Obama foretell just how threatening the FORM Act is to the status quo of central banks’ ‘whatever it takes’ policies of the last seven years, and everything that has been leveraged upon them.

To be sure, quite a lot has been built upon the Fed’s unprecedented policies since the financial crisis; so much so that is has proven exceedingly difficult to navigate away from the emergency measures without suffering the wrath of highly visible market corrections as investors anticipate easy money withdrawal symptoms.  

Despite the Fed’s ‘dual mandate’ of maximum employment and price stability, it shows more and more deference to market price action instead.

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Over the last few years, each time the Fed has appeared poised to raise rates from the current zero-bound policies, the stock market has contracted and the Fed has found cause for delaying the hike further.

This dynamic has enabled the ‘good news is bad news, and bad news is good news’ mindset to take over market patterns.

Any positive economic developments have been met with anxiety over a possible rate hike. All bad economic developments ensured continued or even expanded accommodation by the Fed, and thus climbing stock markets.  

It is endearingly referred to as the ‘Central Bank Put,’ and is dominating capital markets around the world.

Even though the FORM Act is unlikely to pass the Senate this year, the emergence of and increasing momentum of such political developments portend threats of disruption to the aforementioned codependency between the central bankers and capital markets.

In fact, growing acceptance of such proposals and additional Fed oversight bills in the Senate prove the issue has staying power, especially since the Senate bill is cosponsored by two current Republican candidates for President; Senators Rand Paul and Ted Cruz.  

The ongoing Presidential primary contests, and the potential for a Republican inauguration in 2016, mean investors must consider seriously the market implications of putting a leash on the ‘lender of last resort.’

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More than mere questions of a December 2015 interest rate hike or the validity of the latest labor statistics, bills such as the FORM Act would force investors to face a paradigm shift in the Fed’s modus operandi.  

This is especially unsettling for market participants now observing signs of a global slowdown, central banks running low on policy ammunition, and whispers of yet another financial crisis on the horizon.    

When markets highs have been constructed upon the assumption of an unlimited cache of Federal Reserve policy, what happens when political developments demand a change of course?

Expect legislative risks to the status quo, such as the FORM Act of 2015, to continue into 2016 and beyond as the race for President combined with populist political trends serve to undercut the existing state of financial affairs.

Categories: Finance, North America

About Author

Jeffrey Moore

Jeff Moore is a Project Manager and Research Specialist with the North Carolina Department of Commerce, with a focus on legislative, economic and workforce issues. Previously, he served in the Office of Governor Pat McCrory as an economic policy aide and researcher. After earning a BA in Political Science from the University of North Carolina at Chapel Hill in 2007, Jeff worked as a proprietary equity trader, successfully navigating capital markets during the 2008 financial crisis and the ensuing business and political ramifications that followed.