Trump and Yellen: Besties?

Against all odds, Yellen could be an ally to Trump in accelerating growth. Or not.
Photo illustration by 731: Photo: Hisham Ibrahim/Getty Images

The Supreme Court isn’t the only institution President-elect Donald Trump could influence over the next four years. He could also reshape the Federal Reserve—the high court of money. There are already two vacancies on the Fed’s Board of Governors for him to fill next year. Two more seats, including that of Chair Janet Yellen, are likely to open up by the time his term is a year and a half old, giving him a majority of appointees on the seven-member board. He could also put his stamp on the central bank by signing legislation to force the Fed to publish a rate-setting rule and follow it.

Trump’s power to remake the Fed has to alarm the occupants of its headquarters on Constitution Avenue. As a candidate he delighted in bashing Yellen, saying she was keeping rates low to prop up the Democrats. He called her more political than Hillary Clinton. He said the Fed’s cheap money had inflated “a big, fat, ugly bubble” and, with some justification, that savers were “getting just absolutely creamed” by low rates.

But what Trump will do about the Fed once he gets in office is far from clear. He could certainly name Fed governors who would be more hawkish than Yellen and her board allies—more partial to raising interest rates to stave off inflation and keep asset bubbles from forming. It’s also possible, though, that he could revert to his roots as a real estate developer and favor low interest rates that encourage, or accommodate, faster economic growth. A turn to dovishness wouldn’t be surprising—it’s typical for incumbent presidents to want rates low for as long as they’re in office. There’s even talk that Trump could reappoint Yellen to another four-year term when her current one ends on Feb. 3, 2018.

The upshot is widespread uncertainty about the relationship between two people—Trump and Yellen—who were born just two months apart in New York City in the summer of 1946. One is about to become the most important man in the world. The other may already be the most important woman, rivaled only by German Chancellor Angela Merkel. How they spar or cooperate will influence economies and financial markets around the globe. Investors are sifting the evidence for any clue about what will happen. “This is the stuff that we’re just starved for,” says Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock, the giant asset manager.

One thing that’s clear is that Trump could inadvertently box himself in if he names a slate of hawkish Fed governors. In vowing to make America great again, he’s promised to lift the economy’s growth rate, around 2 percent since 2009, to double that or more. Yellen is sympathetic to the need for stronger growth. In an Oct. 14 speech in Boston, she speculated about the benefits of “temporarily running a ‘high-pressure economy,’ with robust aggregate demand and a tight labor market.” Against all odds, she could be an ally to Trump in accelerating growth.

In contrast, some of the people who’ve been discussed as appointees to the Fed are far more skeptical about using monetary policy to rev up the economy. The person most often named as Yellen’s possible successor is the conservative John Taylor, a professor at Stanford University and senior fellow at the Hoover Institution. He invented a rule of thumb for how central banks should steer rates based on the paths of inflation and output. The Taylor Rule caught on around the world in the 1990s and 2000s. But in a Nov. 23 blog post, he wrote that there’s been “a retrogression in parts of the central banking world in the past dozen years”—that is, a deviation from rules-based monetary policy. If Taylor or someone from his camp ran the Fed, the central bank might move quickly to extinguish any deficit-funded growth spurt that threatens to push inflation above the Fed’s 2 percent target. “Trump’s probably not going to like that,” says Paul Kupiec, a resident scholar at the American Enterprise Institute. “It wouldn’t be in President Trump’s best interest for the Fed to come in like gangbusters” in an effort to suppress inflation, says Timothy High, director of U.S. interest rates strategy at French bank BNP Paribas.

It’s possible that Trump will never face this problem because the inflationary growth spurt won’t happen. Republicans who worry about budget deficits might not stand for the combination of higher spending and lower taxes that he envisions. Financial markets, though, clearly expect that he’ll get at least some of what he wants. Stock prices and interest rates have soared since the election.

Such a boomlet would worry enemies of inflation in the Trump camp such as Judy Shelton, co-director of the Sound Money Project at the Atlas Network, which supports free-market think tanks. Shelton has suggested that the U.S. issue gold-backed bonds—one step away from putting the dollar back on a gold standard. But anyone who thinks that Trump himself is a determined advocate for hard money hasn’t been paying close attention. As on several other issues, he’s come down on both sides. In September he told CNBC in a phone interview that Yellen “should be ashamed of herself” for keeping interest rates low. But in the same interview he said that “as a real estate person, I love it” when rates are low. He made clear that what he feared most wasn’t low rates, but what will happen when they inevitably go up. “The new person that becomes president, let him raise interest rates or her raise interest rates,” he told the network. “And watch what happens to the stock market when that happens, OK?”

Yellen has largely kept her counsel about all this—unlike, say, Supreme Court Justice Ruth Bader Ginsburg, who apologized after calling Trump “a faker.” Yellen plays the role of apolitical, affectless functionary. That doesn’t mean she’s powerless to resist pressure from the White House. The president can remove a Fed chair only “for cause,” which typically means misconduct, turpitude, failure to perform duties, or breach of duty. Yellen has told Congress that she “fully” intends to complete her four-year term as chair of the Fed’s Board of Governors.

The seven members of the board, together with a rotating selection of five Federal Reserve Bank presidents, make up the Federal Open Market Committee, which sets interest rates. (The FOMC is widely expected to lift the target range for the federal funds rate by a quarter-point, to 0.5 percent to 0.75 percent, at its Dec. 13-14 meeting.) Trump can name two governors as soon as he takes office because the Republican Senate has refused to act on President Obama’s two nominees. One will become vice chair for regulation, pushing aside Democrat Daniel Tarullo, who’s informally held the role. That could lead Tarullo to resign.

If Yellen is unhappy with Trump’s efforts to exert control over the Fed, she could choose to stay on the board as an ordinary governor after her term as chair is over. Serving out her full 14-year term as a governor would keep her in office until Jan. 31, 2024, when she would be 77. Fed chairs don’t like to hang on that way, says Kupiec, an economist who worked for Alan Greenspan at the Fed from 1988 to 1997. There’s one precedent for staying put: Marriner Eccles completed his term as chairman of the Federal Reserve’s Board of Governors in January 1948 but remained on the board until July 1951.

It’s easy to imagine Trump continuing to pressure the Fed. The harder thing to figure is in which direction, hawkish or dovish. “Trump appointees are likely to shift the needle” toward tighter monetary policy, Ian Shepherdson, chief economist at Pantheon Macroeconomics, told the New York Times right after Trump’s surprise victory. Quite possible. But as Trump has often demonstrated, defying conventional wisdom is what he does best.
With Steve Matthews and Craig Torres

((Deletes incorrect statement in 7th paragraph that Stanley Druckenmiller predicted the 10-year Treasury note yield could reach 6 percent.))
    Before it's here, it's on the Bloomberg Terminal.