Trump’s Fed Chair favorite is bad for gold (but good for the dollar)

BY DEB SHAW | 

  • Trump is apparently favoring John Taylor for the role of the next Fed Chair
  • Despite his calls for higher rates, his appeal lies in protecting the purchasing power of everyday Americans
  • Initial reactions in the dollar and gold suggest what's next

Recent news reports suggests that Trump ‘gushed’ about Stanford University professor John Taylor following his White House interview. After the story was reported in Bloomberg, the US dollar index strengthened on expectations for higher interest rates in the future. The ‘Taylor Rule’, authored by Taylor himself, is a rules-based equation for setting central bank interest rates.

While central banks claim to be ‘data-dependent’, the reality is that monetary policy is driven by committees. Looking at the Federal Reserve, the power to set interest rates is held by the Federal Open Market Committee (FOMC). FOMC board governors meet several times a year and vote on decisions relating to monetary policy. While the committee structure is far more credible than giving the ability to set monetary policy to a single individual, the FOMC has been frequently criticized for lowering the purchasing power of ordinary Americans. This was especially the case following the 2007 financial crisis, when real interest rates were negative. While wealthy Americans were able to hedge the impact of negative interest rates by buying assets such as gold or stocks, middle and lower class Americans suffered as they lost purchasing power.

 

Upending the status quo matches Trump's populist appeal

While the prospect of John Taylor becoming the next Fed Chair was initially dismissed given that his formula calls for much higher interest rates, his odds are rising sharply in betting markets after meeting Trump. Taylor has also tried to downplay his hawkishness, saying that monetary policy should not be entirely dependent on mathematical equations. Instead, he has suggested that the Taylor Rule could bring some much needed transparency to the Fed’s decision making process. Taylor previously called for a neutral interest rate of 4 percent before a House subcommittee in March. The policy rate today is between 1 and 1.25 percent.  

While Trump himself has called for lower rates and a weaker currency, his populist appeal would be strengthened by a Fed Chair who promises to protect the purchasing power of everyday Americans. In our previous take on the next Fed Chair discussion, we suggested that a single individual (even the Chair) would have limited power to change the direction of the organization. Yet promoting the author of the Taylor Rule to the Fed Chair position would be significant for the organization, especially if future monetary policy is ultimately more rules-based.

 

Reactions in the dollar and gold suggest what’s next

If Taylor is selected by the White House to be the next Fed Chair, markets will price in higher interest rates based on the output of the Taylor Rule. While the prospect of rates quickly rising to 4 percent or higher is too extreme, the Fed is likely to become far more sensitive to growth and inflation figures. Recent Fed Chairs including Bernanke and Yellen have taken a dovish view of economic data, and have been criticized for allowing asset inflation in financial markets. If Taylor were to become the Fed Chair, expect the dollar to rise on rate hike expectations and gold to fall on rising real rates.  

Topics: Gold, US dollar
Tags: Trump

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