The FOMC is comprised of up to twelve voting members: seven of them are from the Board of Governors plus the President of the New York Fed who is a permanent voting member and four members from the other eleven regional Reserve Banks who serve a one year term on a rotating basis. The rotating seats are filled so as to ensure regional diversification with one member selected from each of four groups: First, the Boston, Philadelphia and Richmond Fed; Second, the Cleveland and Chicago Fed; Third, the Atlanta, St. Louis and Dallas Fed; Fourth, Minneapolis, Kansas City and San Francisco.
Interestingly, the current FOMC is made up of only ten voting members because only five out of seven seats from the Board of Governors have been appointed: Janet Yellen, Stanley Fischer, Daniel Tarullo, Jerome Powell and Lael Brainard. The President of the United States has to nominate candidates to the Board of Governors who then must be onfirmed by the US Senate. Allan Landon, the former head of Bank of Hawaii, and Kathryn Dominguez, a University of Michigan economist, have been nominated for the Board bu still await confirmation hearings.
In January the next rotation on the board will take place in which we will see Dennis Lockhart (Atlanta Fed), Charles Evans (Chicago Fed), Jeffrey Lacker (Richmond Fed) and John Williams of the San Francisco Fed replaced by Loretta Mester (the Cleveland Fed President), Esther George (the Kansas City Fed President), James Bullard (the St. Louis Fed President) and Eric Rosengren (the Boston Fed President).
This change in composition should tilt the FOMC Board to a more ‘hawkish stance’, at least with respect to the initial rate hike. Three of the four new members are seen as 'awks' n the sense of favouring an initial rate adjustment and the centrist (Rosengren) now appears to lean in that direction. They will replace four members of which only Lacker was seen as a real ‘hawk’. Even the incoming voter Eric Rosengren has noted in a recent speech that “October’s statement explicitly mentioned the possibility that the first move could occur as soon as the next meeting, in December. …I would highlight that the data received recently have been positive, reflecting real improvement for the economy.” He notes that a “potential cost of maintaining the federal funds rate at the zero lower bound for a long time is that it may incent behaviour that would be discouraged in a more normalized interest rate environment” and that “early signs” of this may be showing up in the booming market for ommercial real estate.
ile the new board may be inclined toward a more hawkish tilt on normalising rates, they also have been vocal in advocating a gradualist approach. William Dudley, the President of the New York Fed and a permanent voting member of the FOMC, in a recent speech to the New York Economics Club said: “After lift-off commences, I expect that the pace of tightening will be quite gradual. In part, that is because monetary policy is not as stimulative as the low level of the federal funds rate might suggest. There is strong evidence that the short-term neutral real interest rate—let’s call that r*—is currently quite low, certainly below the level that historically has applied on a longer-term basis.”
This latter issue, namely the ultimate level of the Fed funds rate needed to achieve 'neutrality', will prove to be far more important to financial markets than when the initial rate finally occurs. Dudley clai that the neutral real interest rate ‘r*’ has been depressed by ollar strength reflecting slow global growth and diverging central bank policies, post-crisis estraints on th availability of credit and caution on the part of households and businesses. Even if those factors fade over time, Dudley believes there are more permanent factors that are likely to keep r* below its long-run historical average far into the future. In particular, he cited “potential real GDP growth in the U.S. appears to have declined in recent years—held down by slower productivity growth and demographic factors that are causing the workforce to grow more slowly. This is the main reason why I have cut my estimate of the longer-run federal funds rate in recent years.” If so, normalisation of US short-term interest rates should have a much more muted effect on long-term rates than it had in past cycles.
Provided a central bank is ahead of the curve, yield curves typically flatten as inflationary expectations decline. In the last three tightening cycles the short end of the bond market has delivered losses to investors, however, the long end has tended to perform much better. We expect any move by the Fed to start to raise rates will be well ‘ahead of the curve’ and the yield curve should remain quite flat, favouring positioning at the long end on a duration weighted basis.