Over the years since the end of the financial crisis, Fed-watching has become an obsessive occupation for many investment strategists -- too much so, in our opinion, since it has distracted many observers from a clear view of the bullish, strengthening fundamentals of the U.S. economy. In October, dovish comments from Fed chair Janet Yellen were enough to end a small correction and put markets back in an uptrend. We think that as the U.S. economy continues to strengthen, reaching the long-desired “escape velocity” where it won’t need ongoing Fed intervention, this intense concern with the minutiae of Fed meetings and minutes will fade. For now, it’s still with us, and therefore investors can be sure that the psychology of Fed watching will keep affecting markets at least through the end of 2015. So even though we’re bullish on U.S. economic fundamentals, and bullish on the U.S. stock markets, it’s very worthwhile to look closely at the Fed -- since market participants will still be heavily influenced by their views of Fed actions and intentions.
Fed Voting The Federal Reserve body that makes monetary policy decisions is the FOMC (Federal Open Market Committee). That committee is made up of the Federal Reserve’s Board of Governors (which currently has five members), as well as the presidents of the twelve regional Federal Reserve banks. All the FOMC members attend meetings, but not all are eligible to vote on Fed policy. Voting members include all the Governors, as well as five of the regional bank presidents. Those five rotate annually on a predetermined schedule, with the president of the New York Fed always having a vote due to that bank’s uniquely prominent position in U.S. bank policy and regulation.
This Year’s Voting Changes
As happens every year, voting rights are rotating away from some FOMC members and going to others. Notably, this year, the rotation looks like it will make the Committee, on balance, more dovish -- that is, more inclined to maintain accommodative monetary policy for a greater period of time.
Charles Plosser (president of the Philadelphia Fed) and Richard Fisher (president of the Dallas Fed) will both be losing their voting rights; these two are widely regarded as the most hawkish of the regional presidents, and both dissented in December’s vote, being in favor of more immediate tightening. Cleveland Fed president Loretta Mester, another (albeit more moderate) hawk, will also rotate out. The doves will lose Minneapolis Fed president Narayana Kocherlakota, long one of the FOMC’s most dovish members. Tally: hawks -3, doves -1. New voters will include Atlanta’s Dennis Lockhart and Chicago’s Charles Evans, both doves, as well as dove-leaning San Francisco president John Williams. Jeffrey Lacker, the Richmond Fed chief, will be voting; he was a hawk throughout 2012, when he dissented at all eight meetings, but more recently has seemed more comfortable with current Fed policy. We could call him a moderate hawk. Tally: doves +3, hawks +1. This leaves just moderate hawk Lacker and governor Jerome Powell in the hawk camp. We have governor Daniel Tarullo and vice-chair Stanley Fischer as moderates, with the other six votes from the doves. So given the new weight that the dove wing of the FOMC is getting, as well as the rotation out of two of the FOMC’s most hawkish members, the Committee looks set to tilt decisively towards the doves. The FOMC’s new voting members further bolster our belief that the Fed won’t raise short-term rates until the second half of 2015. Further, historical evidence shows that markets typically continue to rally until the third rate increase -- and we believe that may not occur until well into 2016, or even later.
Investment implications: Since the market watches the Fed with eagle eyes, we do too, even though we see the U.S. economy strengthening to the point where it will be able to function well without Fed training wheels. We note that the composition of the FOMC voting bloc has tilted markedly towards the doves -- and the markets will likely take the view that this could push Fed tightening further out. Such a market view would be bullish for U.S. stocks.