The Fed Is Political: With a Big ‘P’

Summary

• Partisan politics is unlikely to drive Fed policy.
• Yet a Republican victory will not be business as usual and implies upside risks to growth and inflation.
• The Fed can only move policy slowly, and rising risks of Republican victory together with the need to preserve policy optionality create a hawkish policy bias.
• This suggests the June SEP median dot will show only one 2024 cut.
• Based on my expectations of strong growth, inflation and continued strong Republican polling, I expect the September dot plot to show no 2024 cut.
• A November Republican victory could precede a shift to a neutral Fed policy bias in December.

Market Implications

• I still expect no cut in 2024 against 1.7 cuts currently priced in.

Election Polling Raising 2025 Inflation Risks

Chair Jerome Powell has vigorously defended the Fed against allegations of politicization of its decision making, and I believe him. An Arthur Burns-type backroom deal appears very unlikely.

However, the Fed cannot ignore the elections because the outcome will impact the fiscal deficit, growth and eventually inflation.

With the elections less than six months away, polling and betting data suggest Republican control of the White House, House and Senate. In such an instance, we can expect a further loosening of an already very loose fiscal policy, based on tax cuts.

In addition, a Republican victory could trigger a wave of corporate optimism and a pickup in already strong employment and corporate investment.

In short, a Republican victory is not business as usual and involves more upside risks to growth and inflation than a Democratic victory.

Fed Policy Can Only Change Slowly

The Fed moves its policy stance slowly. This mainly because it reacts to the broad economic picture, which moves slowly (economic time is much slower than market time!), and because of policymaking constraints. For instance, in 2022, the Fed felt it could not start hiking until the QE taper was over, which delayed its response to high inflation. In 2023, bank failures revealed the risks associated with fast FFR increases.

So the Fed will be very careful not to be caught with an easing bias when growth and inflation risks are rising. This implies it must start positioning now for a potential Republican victory.

This is a hawkish factor for Fed policy, independent from growth and inflation data. To position for upside risks to inflation and growth in 2025, the Fed will need to have withdrawn from its easing bias by end-2024. This implies a gradual removal of the three 2024 cuts in the March dot plot, starting to move to only one 2024 cut in the June plot.

Based on my expectations of continued strong growth and inflation, the September dot plot could show no 2024 cut. This would allow the Fed to move to a neutral bias at the 18 December FOMC if the Republicans win the 2024 elections.

In that sense, the Fed is Political but with a big rather than small ‘P’.

Market Consequences

I still expect no cut in 2024 against the markets currently pricing 1.7.

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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)