Tarullo Resigns- Trump Fed Picks Coming

Daniel Tarullo, the Fed’s top regulator stepped down on Friday, effective April 5th, 2017. Tarullo was chairman of the board’s Committee on Supervision and Regulation. He also was chairman of the Financial Stability Board’s Standing Committee on Supervisory and Regulatory Cooperation. He’s also a voting member of the central bank’s policymaking panel. He’s been a member of the Fed’s Board of Governors since 2009. He was an Obama appointee. Tarullo was a key figure in getting the Dodd-Frank banking regulations passed. Tarullo claims he didn’t leave for political reasons, but it’s obvious he did. Trump was preparing to fill the Federal Reserve vice chairman postion in charge of bank oversight. This is one of the two vacancies Trump must fill. Even though Tarullo didn’t fill this role, he acted as if he did. Tarullo’s term ended in 2022. By stepping down, this makes it easy for Trump fill this role without there being conflicts within the agency.

The main takeaway from this story is Trump will have an easier time dismantling Dodd-Frank which is great news for the financials. It’s also great news for community banks which have had tough time complying with Dodd-Frank. Some community banks have had to shut down due to the high costs it imposed on them. I’ve spoken to the CEO of a community bank in Ohio who told me the struggles Dodd-Frank brought his bank. The legislation is bizarre because the goal was to prevent another financial crisis, but it did the opposite by weakening local banks. Local community banks clearly didn’t cause the financial crisis. Government regulations caused the financial crisis in the first place, so it’s an oxymoron to think the government can prevent another crisis. Government guaranteed mortgage loans created a bubble in housing. The government shouldn’t get involved with allowing people who can’t afford a house to buy one.

The reason Dodd-Frank is focused on in this story is because that’s what Tarullo was specifically involved with. However, only paying attention to this would be ignoring the big picture. Frankly, I’m shocked by the market’s reaction to the uncertainty with monetary policy. As someone who has a good track record with predicting Fed policy, I can say I am not certain which direction Trump will go in with his picks. I guess if you’re a member of the consensus, you always think monetary policy is uncertain because the consensus has consistently overestimated the amount of Fed rate hikes. It’s not complicated; the Fed wants to raise rates as slowly as possible and doesn’t want to unwind the balance sheet. If you take their words at face value, you may be confused, but if you follow their actions, it’s simple.

I’m shocked because in early 2016 the market reacted to a quarter point rate hike like it was the end of the world. This correction was logical because the Fed has propped the market up and is now slowly taking away the punch bowl. Now, there’s a chance Trump can appoint hawks. He can shape the Fed before he picks who will be the new chairperson next year. To analogize this situation, the market is like a kid who is learning to ride a two-wheeled bike. The kid is very nervous at first and wants the parent to hold it while it rides. The first time the kid rides without the parent, it crashes into the bushes. The first crash into the bushes for the market was the taper tantrum in 2013 when bond yields rose after the Fed tapered its QE program. The second crash into the bushes was when the stock market corrected after the rate hike in December 2015.

After the kid crashed when the parent let go, the parent went back to holding on. This is akin to the Fed slowing its rate hike program to one per year. Then, the kid sees its friends riding bikes, so it decides it wants to go down a massive hill. If the market is willing to accept rate hikes and the Fed selling the government bonds on its balance sheet, then it is like the kid about to go down the hill. I think most market participants are aware of the possibility Trump picks hawks, but it hasn’t been a story because the market has kept going higher. This blind ignorance is bad because if the market responded negatively to Trump’s hawkish leanings, he may notice the consequences of picking a hawk and moderate his stance.

From a long term perspective, it is great if Trump pick a hawk, but usually the market doesn’t like taking short term pain for long term gain. The market couldn’t even handle a rate hike, so I’m confused how it can ignore what’s coming. Trump is also making it tougher on his fiscal policy if rates go higher because it means it will cost more to service the debt. The math on funding the tax cuts is already fuzzy. It doesn’t need to be further complicated.

While Tarullo made it easy on Trump in this instance, the Fed is currently making it more difficult on him. The reason I say this is because the Fed has lately become more cautious about raising rates because it’s uncertain about fiscal policy. You can argue this is the same old Fed who will make any excuse to not raise rates, but this time is different. If Trump is expected to appoint hawks, it would ease the transition process if the Fed talked tough on rate hikes. There will still be a wide difference in policy between Obama and Trump appointed officials, but the current Fed could try to bridge the gap.

I think the reason the current Fed isn’t trying to bridge the gap is because the white house is not communicating its monetary policy. Just like how the Fed says it won’t raise rates because it doesn’t know what will happen to fiscal policy, the Fed also doesn’t know what Trump’s plans for the Fed are. The Fed is like a deer in headlights; it doesn’t know what to do, so it does nothing. Trump’s antipathy toward the Fed is the very reason why he’s going to change its policy. This antipathy is going to hurt the ability to get that policy done because he’s not communicating a proper transition to the Fed or to the market

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