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Talking Points/Larry Edelman

The Federal Reserve reaches truce with markets, but pays a price

Federal Reserve chairman Jerome Powell.AP

The high-stakes skirmish between the Federal Reserve and Wall Street over the path of interest rates is over. At least for now.

That helps explain why, after frantically pushing US stocks to the brink of a 20 percent decline (a dreaded bear market), investors have reversed course. The Dow Jones industrial average rose 2.4 percent last week, and since its nadir on Dec. 24, the benchmark has rallied 10 percent.

Why the mood swing? Diagnosing the psychology of the market is more Freud than Einstein. But something quite unexpected had transpired: The Fed, facing strong criticism from Wall Street and the White House for its campaign to raise interest rates to more normal levels, concluded it was best to take a breather.


It was a decision with enormous implications for the economy, the Fed, and President Trump’s reelection campaign.

How so? First a quick recap.

On Oct. 3, Fed chairman Jerome Powell ignited the fourth-quarter market meltdown in an interview with Judy Woodruff on PBS. “We’re gradually moving to a place where [interest rates] will be neutral,” he said, referring to the level where rates neither fuel the economy nor inhibit it. “We may go past neutral, but we’re a long way from neutral at this point, probably.”

Powell — worried that unemployment at nearly 50-year lows would spark inflation — was saying that rates would continue to climb. Wall Street, by contrast, was sure that economic slowdowns in Asia and Europe, plus trade tensions with China, would cool the US economy. Tighter credit, investors fretted, could needlessly cause a recession.

On Dec. 19, when the central bank boosted rates by another quarter point, it also cut the number of expected rate hikes for 2019 from three to two. After that failed to calm investors — and Trump tweeted on Christmas Eve that “the only problem our economy has is the Fed” — Powell took a surprise turn, saying during a panel discussion in Atlanta that investors had pushed down stock prices based on gloomy expectations that were not warranted by economic data. But, he added, “We’re listening carefully to that. We’re listening sensitively to the messages markets are sending.”


The Fed was making clear it was taking investors’ concerns to heart, and Powell promised to be “flexible and patient” when charting the course of interest rates. Wall Street took the comments to mean that the two rate hikes penciled in for this year were not set in concrete, and maybe would never happen. The Fed Freakout was over.

But it’s too soon to sound the all-clear. Global growth is still weakening, the United States and China have yet to reach a trade deal, and fourth-quarter earnings reports, which begin in earnest this week, could bring some nasty surprises. On Monday morning, US stock futures are down after China reported weaker-than-expected trade data.

Moreover, key questions linger: Did the central bank back down to appease investors and Trump? Will the president think he can improve his reelection chances by jawboning the Fed into keeping interest rates low through 2020? Has the Fed’s all-important independence from Congress and the White House taken a permanent hit?

Globe reporters and editors put these questions to Eric Rosengren, president of the Federal Reserve Bank of Boston, when he sat down with our editorial board on Friday. Like all regional Fed presidents, he takes part in rate-setting discussions by the Federal Open Market Committee, and this year he will be a voting member of the powerful committee.


Rosengren, who has run the Boston Fed since 2007 and is known for his vigilance against rising prices, said that he and his FOMC colleagues found themselves in a bind in the latter half of December. There was a yawning gulf between their upbeat view of the economy and Wall Street’s belief that the good times were ending. After the S&P 500 index fell 19.6 percent from its peak on Oct. 3 to Dec. 24, something had to give.

“If financial market participants are very concerned, that’s something I have to take on board,” Rosengren said.

Why? Because continued deterioration in the markets could erode what is now strong consumer confidence, Rosengren said, noting that when he returned to the Boston Fed’s washboard-tower headquarters on Atlantic Avenue after the December holiday break, employees were asking him if they should be worried about their 401(k) retirement accounts.

Was Trump’s unprecedented public haranguing of the Fed a factor? Only to the degree that it exacerbated market turmoil, Rosengren said. The sell-off that started in October had increased the chances that the Fed’s forecast for continued growth would prove to be too rosy.

After hearing out Rosengren for more than an hour, I think the FOMC did the right thing. Caught between a rock and a hard place, it decided to bend but not break. It took the risk of nicking its reputation in order to concede that, yes, the world had become a more uncertain place and it needed to step back and wait to see what happens.


But I worry that Trump sees it differently and that he won’t hesitate to meddle publicly and privately in monetary policy. He needs a good economy — and rising stock prices — to win a second term. Remember what happened to George H.W. Bush. A recession and Bill Clinton’s “It’s the economy, stupid” made him a one-term president.

I worry that Trump will try to further undermine that Fed’s credibility — as he has tried to undermine the integrity of the FBI, Justice Department, and CIA — if it’s politically expedient.

And I worry that in the future, investors will expect the Fed to bail them out with cheap money when markets inevitably turn ugly, even if it’s not the best move for the economy.

Rosengren said the Fed will remain protective of its independence. And Powell did push back against Trump, indirectly, during a Q&A session in Dallas on Nov. 14.

When asked about the president’s attacks on the Fed, he said: “Our accountability is really to Congress . . . Independence from presidential criticism has long been a hallmark of the Fed’s existence.”

Indeed, in his meeting at the Globe, Rosengren pointed out one of the darker episodes in the Fed’s history. In the late 1960s, with unemployment low and the Vietnam War pushing inflation above 5 percent (we are at 2 percent now), President Nixon privately made it clear to Fed chairman Arthur Burns that he wasn’t happy with rising rates. Historians say Burns didn’t move as aggressively as he should have to tamp down rising prices, and his accommodation of Nixon helped fuel the inflationary spiral of the 1970s.


“Whenever you look at the history of the Federal Reserve, that’s not looked at as a bright spot,” Rosengren said.

Democrats love to draw parallels between Trump and Nixon. Let’s hope Powell doesn’t suffer the same fate as Burns.

Because it’s important to remember that despite what the president may suggest, the Fed is not the enemy.

You can reach me at larry.edelman@globe.com and follow me on Twitter @GlobeNewsEd. Sign up for my Talking Points AM newsletter here.