Think of the Fed as if it were your favorite baseball team. Fans may be loyal to one team, but they know the lineup changes. They know there are winning seasons and losing ones. The handicapping process never ends. They wonder if veteran players still have what it takes. They wonder if there are any promising rookies joining the team. Or if the general manager is working on some trades. These are the questions baseball fans ask. You need to ask the same questions of the Fed. Before we drill down on the Fed’s lineup for next season, it’s useful to review the Fed’s structure. The Fed is a strange hybrid of public and private elements. The Fed is a “system” of 12 regional reserve banks supervised by a board of governors. The 12 regional banks are located in major cities around the country (Boston, New York, Chicago, etc.). The regional banks are privately owned by the commercial banks in each region. Those private stockholders elect a board of directors, and the directors hire a president for each regional reserve bank. The board of governors of the entire system is based in Washington, D.C. The board consists of seven members selected by the president of the United States and confirmed by the U.S. Senate. Among the board of governors is a chair and a vice chairman also selected by the president and confirmed by the Senate. This arrangement gives a total of 19 principal policymakers — seven governors plus 12 regional reserve bank presidents — some appointed by the president and some hired indirectly by private banks. Things get more complicated from there. Interest rate policy is not made by the governors alone or by the reserve bank presidents. It is set by the Federal Open Market Committee (FOMC). The FOMC meets eight times per year (about every six weeks). It has 12 members consisting of all seven members of the board of governors plus five of the 12 regional reserve bank presidents. Still with me? Good, because it gets even more complicated… but you’ll understand it all when I’m finished. Of the five regional reserve bank presidents who can vote on the FOMC, one has a permanent seat. That’s the president of the Federal Reserve Bank of New York. The other four rotate from among the remaining 11 regional reserve banks on a one-year term. This rotation is important because some of the regional reserve bank presidents are “hawks” (favoring a rate hike). Some others are “doves” (favoring continued ease). Knowing which are on the FOMC each year is part of what you need to know to forecast policy. Even with this FOMC formula in mind, there are still surprises. Fed officials often quit or retire before their terms expire (to return to academia or pursue other business opportunities). This can lead to surprise appointments by the president or vacancies, which skew the voting one way or another. As they say in baseball, “You can’t tell the players without a scorecard!” Let’s look at the FOMC scorecard and see what it can tell us about future Fed policy. Right now there are two vacancies on the board of governors. This means that there are only five governors on the FOMC: Janet Yellen, Stanley Fischer, Lael Brainard, Jay Powell and Dan Tarullo. The other five seats are taken up by the following regional reserve bank presidents: Bill Dudley (New York), Charles Evans (Chicago), Dennis Lockhart (Atlanta), John Williams (San Francisco) and Jeffrey Lacker (Richmond). For all practical purposes, the center of gravity comes down to Yellen, Fischer and Dudley. They are the “Big Three.” The other governors (Brainard, Tarullo and Powell) are relatively new. Jay Powell has been relatively quiet on monetary policy. Lael Brainard and Dan Tarullo shocked markets this week by breaking with Janet Yellen. On October 12, Lael Brainard gave a speech in Washington, DC that was super-dovish. She poured cold water on the idea that the unemployment rate was a good predictor of inflation. She said that inflation is nowhere in sight and this is no time to raise rates. The next day Dan Tarullo gave an interview on CNBC where he said much the same thing. To have two governors challenge Yellen in two days looks like a revolt in the ranks. Yellen must have had a hard time persuading them to go along with a rate increase even if she had Fischer and Dudley in her camp. Among the regional reserve bank presidents, Evans is an outspoken dove and Lacker is an outspoken hawk. They cancel each other out. Lockhart and Williams are both “moderates” who will also go along with Chair Yellen. My sources inside the Fed have told me that the board of governors don’t give any particular weight to the views of the regional reserve bank presidents anyway. The chair lets the voting and nonvoting presidents have their say in the FOMC meetings. That tends to dilute the views of the voting presidents. The result is that the Big Three still hold sway. This lineup changes again next month. Evans, Lockhart, Williams and Lacker will go off the FOMC at that point. They will be replaced by Loretta Mester (Cleveland), Eric Rosengren (Boston), James Bullard (St. Louis) and Esther George (Kansas City). Once again, the regional reserve bank presidents are split. Mester, George and Bullard are all hawks, while Rosengren is a dove. However, Rosengren is not as outspoken and does not have the intellectual firepower that Evans brought to the debate this year. The line-up is changing but the confusion continues. The governors are more dovish (because of the Brainard and Tarullo revolt against Yellen). The regional reserve bank presidents are more hawkish (because Evans is leaving and three hawks are joining). It’s a close call, but overall the FOMC looks slightly more hawkish beginning in 2016. But only slightly. The entire FOMC, governors and presidents, is “data dependent.” Whatever their biases and previously stated views, they will carefully weigh the data and trends at each FOMC meeting. The FOMC will take the process one meeting and one data point at a time. The next two FOMC meetings are Jan. 27-28 and Mar. 17-18. If there is another rate increase, it is likely to have devastating effects on emerging markets and lead to increased tensions in the currency wars and a further correction in the U.S. stock market. It is possible that the Fed will raise rates at these meetings. It depends on if there is any strength in the data. Bottom line: My forecast is that the economic data will remain weak and the Fed’s next move will be toward easing, probably by mid-2016. If the data are stronger than I expect, the Fed will raise rates further. The best way to play this forecast is to buy gold and high-quality gold mining stocks. If the Fed eases, gold will rally on expected inflation. If the Fed tightens further, that means inflation has appeared, and gold will rally on actual inflation. Either way, gold should rally. Whatever the process involves, and whatever the policy, we will be watching closely and keeping you ahead of the curve every step of the way. All the best, Jim Rickards
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