This article was originally published in Forbes
Our third article on the Fed leverages third-party political trend data as well as powerful Sentieo opinion mining to break down past speeches from top contenders for the Fed Chair. We discuss possible 2018 scenarios and delve deeper into the surprising results we come across. Brush up on the previous articles and see what’s coming up next in our series using the FedSpeak lexicon here:
Sentiment Analysis Of FOMC Statements Reveals A More Hawkish Fed
Why Is The Fed Still Raising Rates? The Yellen Effect
Assessing Fed Chair Hopefuls With NLP Analysis Of Past Speeches
Predicting The FOMC Statement With Beige Book Sentiment Data
We set out to analyze the historical speeches of the top Fed candidates with Sentieo’s natural language processing capabilities and in the process, we learned something interesting. It doesn’t matter.
The Federal Reserve is not a one-woman organization and while the chair tends to drive policy, the minutes reveal that the entire committee weighs in on decisions. Some subtle changes over the course of this year have changed the makeup of the FOMC into a more hawkish committee. Furthermore, the composition of the FOMC will change when four of the regional bank presidents and voting members rotate out for their peers.
Earlier this year, Daniel Tarullo resigned. And just a little over a month ago, Stanley Fischer, a longtime central banker, resigned from Fed Board of Governors. In their place, Donald Trump has nominated Randal Quarles, a monetary hawk who favors a rule-based approach to monetary policy, as vice chair for bank supervision. Unfortunately, transcripts of Mr. Quarles views on monetary policy are not readily available, so he is not included in the quantitative analysis.
Who will get the nod?
Rather than analyze every proposed Fed chair that has been mentioned in the news, we used the wisdom of crowds to narrow down the analysis.
Political prediction market PredictIt shows that current governor Jerome Powell is the frontrunner by a wide margin, followed by Stanford professor with famously controversial views on monetary policy John Taylor and current chair Janet Yellen. Probabilities of nomination for Gary Cohn and Kevin Warsh have decreased dramatically and Neel Kashkari has never really been a serious contender. These predictions may change in real-time and are based on those at time of publication.
Where do the contenders stand?
We analyzed the top four contenders using a corpus of their past speeches and written work on monetary policy and the Sentieo FedSpeak lexicon, looking for the way they mentioned inflation and unemployment. Each mention is scored as either hawkish or dovish, and the total score is equal to (hawkish mentions – dovish mentions) / total words.
Powell is clearly less hawkish than either Yellen or Taylor. On a standalone basis, it would appear that this choice should matter.
However, the overwhelmingly hawkish change between the 2017 Fed and the 2018 Fed renders the Chair decision almost meaningless.
The early 2017 Fed (before the resignation of Tarullo and Fischer) had a mean hawkishness of 0.24%.
But the loss of Fischer and Tarullo in 2017 meaningfully shifts the balance for 2018. The new 2018 FOMC under any of the top four frontrunners will be more hawkish.
It is important to note that there are still three open positions on the Federal Reserve Board of Governors and President Trump has the power to fill all of those positions. If Powell is nominated as chair he will leave four open seats that can dramatically alter the makeup of the committee. Monetary policy positions do not necessarily align with politics so it not a sure thing that he will nominate a hawk. If President Trump were rational, we would expect him to nominate doves who will keep interest rates low and avoid dulling the stimulus effect of his tax plan on the economy.
What will happen to rates?
CME Fed Funds rate futures markets are in consensus about a rate hike in December of this year. However, after that, the markets are more divided. In March of 2018, there is a 57% probability the target rate will be at 125-150 bps and 40% probability at 150-175. In June, there is a 35% probability the target rate will be at 125-150 bps, 45% probability at 150-175, and a 17% probability at 175-200. A decade of loose monetary policy may be coming to an end with a more hawkish panel of decision-makers, still dependent on three very important and undecided factors of course.