The Fed is about to see loads of new faces. What it means for banks, the financial system and markets


Sarah Bloom Raskin

Andreas Harrer | Bloomberg | Getty Images

In probably just a few months, the Federal Reserve will look very different: three new governors, a new vice chairman, a new bank chief, and probably a few new regional presidents.

But while parts of the institution’s upper tiers may change quite a bit, the whole could look pretty much the same.

That’s because Fed watchers are unlikely to change much ideologically even if Sarah Bloom Raskin, Lisa Cook and Philip Jefferson are confirmed as new members of the Board of Governors. White House sources say President Joe Biden will nominate the trio in the coming days.

Of the three, Raskin is considered the greatest change agent. She is expected to take more responsibility in her future role as deputy chair of banking supervision, a position held until December by Randal Quarles, who took a lighter note.

Bankers may be surprised that the rhetoric might be a bit more extreme. But the substance? What are they gonna do to these guys?

Christopher Walen

Founder, Whalen Global Advisors

But while Raskin might be stepping up rhetoric about the financial system, how much will that actually translate into policy?

“She is a former regulator. She knows about these things. They won’t mess that up,” said Christopher Whalen, founder of Whalen Global Advisors and former Fed researcher. “Bankers will be surprised that the rhetoric might be a bit more extreme. But the substance? What are they gonna do to these guys? It’s not like they take a lot of risks.”

In fact, the proportion of quality capital US banks hold relative to risky assets has risen steadily since the 2008 financial crisis, from 11.4% at the end of 2009 to 15.7% in the third quarter of 2011 data, according to Fed data.

Still, the banking industry remains a favored target of Congressional Democrats, led by Massachusetts Senator Elizabeth Warren, who is believed to have favored Raskin for the oversight role.

However, the candidate’s greatest impact could be in some of the sub-areas where the Fed has dipped its toes recently, such as:

“The main bone of contention with her confirmation will be climate policy, where in the past she has expressed support for the implementation of both monetary and regulatory policies by the Fed in a way that promotes the green transition,” said Krishna Guha, Head of Global Policy and Central Bank Strategy for Evercore ISI.

While Guha sees Raskin “taking a materially more stringent regulatory line” than Quarles, he also sees them as “pragmatic” on issues such as reforms in the treasury market, particularly changes in the supplementary leverage ratio in the pandemic era. The SLR mandates the weighting of assets held by banks, and industry leaders have called for changes to differentiate between things like government bonds and other far riskier holdings.

The financial system has continued to experience unusual trends even in the pandemic era, such as: B. Dramatically higher liquidity demand from the Fed’s overnight repo arrangements, which allow banks to swap high-value assets for cash. The operations set an all-day record on New Year’s Eve 2021 when nearly $2 trillion changed hands, and Thursday’s activity saw more than $1.6 trillion in transactions.

Monetary policy challenges await

These issues will demand attention from Raskin, as will broader monetary policy issues.

Cook and Jefferson are expected to bring dovish views to the board, meaning they favor looser policy on interest rates and other such matters. However, if confirmed, they would come to the board at a time when the Fed is pushing for a more hawkish approach, embarking on rate hikes and other tightening measures to control inflation.

“We think it would be a mistake to think that if they arrived, they would likely form a hardline moderate bloc and resist the Fed’s hawkish change in policy,” Guha wrote. “Rather, we think they – like [Governor Lael] Brainard and other former pigeons [Mary] Dalí and [Charles] Evans – will look at politics as a game of two halves and explain what that means and how it might play out.”

Daly is the San Francisco Fed President, while Evans runs the central bank’s operations in Chicago.

You have been speaking alongside several other policymakers over the past few days about the need for a rate hike. So even if the new trio of officials came in to hit the brakes on policy tightening, they would likely be drowned out by a desire to stem price hikes, which are running at the highest rate in nearly 40 years. The Fed is also expected to end its monthly asset purchases in March

Where the board seems less determined is in reducing some of the more than $8.8 trillion in assets the Fed holds. Some officials said at the December meeting that the balance sheet contraction could start shortly after the rate hikes start, but others have expressed uncertainty about the process in recent days.

“People want the Fed to do something about inflation. But if growth slows in the spring, people won’t be paying higher borrowing costs,” said Joseph LaVorgna, chief economist for the Americas at Natixis and chief economist for the National Economic Council under ex-President Donald Trump.

“They’re going to be pretty dovish on the interest rate side and they might actually roll back on the balance sheet contraction,” he added.

Other changes for the Fed include Brainard likely to serve as vice chair of the Federal Open Market Committee, which sets interest rate policy. The position effectively makes its chairman, Jerome Powell, the first lieutenant; Testimonies during her Senate confirmation hearing on Thursday indicate she is likely to be voted through.

There are also two regional presidential posts open after Boston’s Eric Rosengren and Dallas’ Robert Kaplan resigned last year amid controversy over market dealings by Fed officials in the early days of the pandemic.

Whalen, the former Fed official, said the new policymakers will have enough to keep them busy, although they’re unlikely to push for sweeping changes.

“I think Fed governors will actually spend more time talking about financial markets this year than they have in the last few years,” he said. “It’s very clear that they made mistakes, but they’re not very good at saying that.”