Fed Watch: Steady as She Goes – In More Ways Than One

Tim Duy brings us his latest Fed Watch:

Today’s CPI report does little to change the course of Fed policy. Indeed, it will help cement the “measured” pace of tightening for the near future. On the back of another strong gain in transportation costs (read: gasoline) headline CPI gained 0.5% in April. But in a surprising development, core prices remain unchanged. I will leave it to others to parse out the details of the reports; there are, as always “special” circumstances hidden within the individual components. I have never been very confident Fed policymakers are much concerned with the underlying details, unless, of course, one detail begins to dominate the overall data. The Fed will concentrate their attention on the core numbers, and conclude...drum role, please….that one month does not make a pattern.

To be sure, there will be some relief on Constitution Ave. that the report did not surprise on the upside and drive expectations for a more than measured response. Still, core-CPI is growing at a 2.6% annual rate for the last three months, clearly above the Fed’s comfort zone. This underlying trend will remain the Fed’s focus until it reverses itself (unlikely) or growth slows significantly.

Why do I keep harping on the necessity for a significant slowing in growth before the Fed changes course? Just look at yesterday’s comments by Fed Governor Donald Kohn, speaking to the Australian Business Economists: “…if growth is sustained and inflation remains contained, we are likely to raise rates further at a measured pace.” And “The federal funds rate appears still to be below the level that we would expect to be consistent with the maintenance of stable inflation and full employment over the medium run.” And, if that wasn’t clear enough, “[W]e have not yet finished this task.” These are remarkably candid remarks, and imply a high degree of confidence in the continuance of existing policy. The recent bearish feelings on Wall Street are clearly not receiving much validation in the inner circles of the Fed.

In other Fed news, it was announced this morning that Governor Edward Gramlich has tendered his resignation, three years before his term was scheduled to expire (14 years is a long time, and Gramlich took a spot with 11 years remaining on the clock). I think this event will have little near term impact on policy. Indeed, perhaps the candor of Kohn’s remarks was preparation for the announcement of Gramlich’s departure. Gramlich was a somewhat dovish member of the FOMC, and some could interpret his departure as setting the stage for a more aggressive policy. Kohn’s comments should help ease any such concerns. I will not comment on possible replacements for Gramlich; your guesses are as good as mine.

Regarding replacements, however, the Washington Post is reporting this morning that the Administration is considering delaying Greenspan’s departure. This is indeed important for policy, and confirms what I think many of us has felt: That none of the names commonly mention for the Fed’s top spot, Feldstein, Hubbard, and Bernanke, fill our hearts with warm fuzzies. Indeed, the fact that this story was floated should make Bernanke think twice before moving to the CEA. Apparently, there is no guarantee of a Fed chairmanship down the line.

Is the Administration somehow rewarding Greenspan for supporting tax cuts? I doubt it. Instead, the possible delay more likely reflects the challenges of finding a suitable replacement. Academic? Industrialist? Financier? Or academic turned industrialist? Moreover, is there pressure in the Administration to appoint simply on the basis on politics, rather than on the best person for the job? This is my greatest fear. The economy can survive a John Snow as Secretary of Treasury. The same is not true for the Fed Chair.

Would former Treasury Secretary Robert Rubin be a good replacement? Probably – but not realistic. This Administration will not put the good of economy ahead of politics. Rubin is a Democrat – enough said.

More generally, what does the difficulty of finding names say about the importance of Greenspan? I don’t want to believe that only he can do this job. If the Administration delays his retirement, it suggests that this is true, casting a pall over Greenspan’s eventual successor and diminishing their credibility. Is this how we want to start off the tenure of fresh blood in the Chairman’s seat? I don’t think so. Maybe the blogging community should turn a fresh eye to the question of possible names to replace Greenspan….

[Update:  Calculated Risk comments on the administration's claim of needing more time to broaden the search: "'More time to broaden the search'? The White House wasn't aware that Greenspan was retiring in January?" Brad Delong notes Calulated Risk's post and further notes the misrepresentation of Volcker's background in the article.  William Polley says: "Appoint a successor sooner rather than later and don't play games with this position." The Prudent Investor weighs in with "Any delay could wreak havoc on the markets," and Global Trader Diary discusses at the possibility of deviating from a measured response.]

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