Fed's Policy Divergence: Powell's Consensus-Building Ability Faces Ultimate Test

Key Takeaways:

• Growing divisions within the Federal Reserve's monetary policy committee.
• Challenges to Powell's consensus-building ability.
• Impact of divisions on future policy decisions.
• Potential risks to markets due to policy uncertainty.

As the fog of economic uncertainty thickens, the divisions and dissents within the Federal Reserve's 19-member monetary policy committee are intensifying, posing a significant challenge to Chairman Jerome Powell's consensus-building prowess.

While the Fed's decision to cut interest rates last week was not entirely unexpected, the meeting was historic nonetheless. The 10-2 vote to lower the benchmark rate by 25 basis points marked only the third time since 1990 that voting members simultaneously favored tightening and easing monetary policy.

Christopher Waller, appointed by President Trump, voted for a 50 basis point cut, while Kansas City Fed President Jeffrey Schmid dissented in favor of holding rates steady.

These rifts were highlighted in Powell's press conference following the meeting. He told reporters that officials had “sharply different views about how to proceed,” meaning that a December easing wasn't the “done deal” the market had previously anticipated. Indeed, the December decision could be akin to flipping a coin, choosing between another 25 basis point cut or standing pat.

All of this is happening at a challenging time. Investors must not only grapple with an economic data drought caused by the government shutdown, but existing indicators also point to a weakening labor market, while inflation remains stubbornly persistent. Simultaneously, the Fed is facing intense politicization, with the Trump administration attacking the central bank's independence while also preparing to nominate Powell's successor next year.

For markets, and especially a market already pricing in perfection, this is a perfect storm they least need.

Hawks vs. Doves

Broad disagreement is common in a committee comprised of Fed governors and the presidents of the 11 regional banks.

Generally speaking, the current divide between “doves” and “hawks” appears to roughly pit the governors on one side and the regional bank presidents on the other. There are centrists in both camps, but the governors tend to lean toward looser policy, while the regional bank presidents are more cautious about further rate cuts.

Since the Fed's meeting last week, Dallas Fed President Lorie Logan, Kansas City Fed President Jeffrey Schmid, Cleveland Fed President Loretta Mester, and Chicago Fed President Austan Goolsbee have all expressed concerns about lowering rates.

Meanwhile, governors Waller and Bowman have publicly supported last week's rate cut and favored further easing. Waller and Bowman are both on Treasury Secretary Janet Yellen's shortlist to succeed Powell, whose term as chairman ends next May.

“Noisy and Messy”

As recent policy meetings have demonstrated, Powell's leadership and consensus-building abilities will be severely tested in this environment. Governors Waller and Bowman dissented at the July meeting, favoring rate cuts, and last month there was historic two-way dissent.

True, the regional bank presidents who don't have voting rights are flexing their influence, but how effective this ultimately will be remains to be seen. As Tim Duy, chief U.S. economist at SGH Macro Advisors, pointed out, “power resides with the board.”

“It is harder for Powell to achieve consensus in this environment,” Duy said, adding that Powell has done a “remarkably good job” in that regard during his years as chairman.

If this policy polarization intensifies, many investors operating in the market today will find themselves in unfamiliar territory because they've become accustomed to well-communicated, consensus-driven policy from the Fed.

James Egelhof, chief U.S. economist at BNP Paribas, believes the “high degree of consensus” that investors have become used to may be “elusive” in the coming months.

Egelhof still expects the Fed to cut rates again, including in December, but he also thinks we may see a “noisy and messy” process that leads to a path that is “bumpier and less predictable” than investors typically face.

“Polarization leads to uncertainty,” he said.

Of course, greater policy uncertainty often fuels increased market volatility and risk aversion, which theoretically should be reflected in rising risk premiums or widening spreads. But that has not happened yet. But if the newly emerged divisions within the Federal Open Market Committee (FOMC) continue to widen, we may see it.