Fed independence crucial for long-term stability

Ensuring the independence of the Federal Reserve Board is crucial to market stability and investor confidence, says Giuseppe Pietrantonio, director and vice-president, multi-asset and currency solutions, CIBC Asset Management. 

In a Sept. 24 interview, Pietrantonio said U.S. President Donald Trump’s recent musings about influencing the Fed’s actions violate the long-held norm that monetary policy should be separate from political agenda.

“To have a credible or independent central bank is crucial because [bank governors] aren’t swayed by any political influences,” he said, adding that their interests lean toward long-term stability, as opposed to short-term gains.

Listen to the full conversation on the Advisor To Go podcast, powered by CIBC Asset Management.

Governments tend to change every few years, Pietrantonio noted. Having a central bank that does not base its decisions on the whims of political administrations provides much-needed stability.

When that stability is put to question, “market participants start to get a little jittery,” he said.

For instance, despite expectations for falling rates, five- and 10-year U.S. Treasury yields haven’t dropped much. This may reflect market doubts about the Fed’s independence. If it’s in question, investors may demand a higher premium due to perceived higher long-term risk.

Pietrantonio used Turkey as an example of a country whose central bank has lost its independence over the past three years. Political interference has caused Turkish bond yields and inflation to increase significantly, and the Turkish lira to depreciate.

These results are directly attributable to markets questioning the stability of a non-independent central bank, he said. 

Pietrantonio pointed out that the U.S. relies on foreign direct investment (FDI) to fund its deficit. Without it, yields rise to attract investors. Government interference with central banks risks unsettling capital markets.

And where do the main differences of opinion between the Fed and U.S. government lie? 

Rate cuts is the key area, he said. With inflation slowing, the U.S. government is urging the Fed to lower rates, following the lead of central banks like the Bank of Canada and European Central Bank. The U.S. government’s main goal here is to boost growth, he said.

“The Federal Reserve is not necessarily always concerned about growth,” he said. “They want to make sure inflation is at the right level, [and] unemployment is at the right level. So, once again, this dichotomy that the Fed has in terms of this balancing act is very, very tricky.”

Unemployment is slowing in the U.S., adding more pressure on the Fed, Pietrantonio said. With inflation still sticky, the Fed must weigh the impact of keeping rates high in an attempt to control inflation against cutting rates to support growth and jobs. 

“I think the balance of risk here is that they will cut,” he said. “I think we’ll start seeing softening of inflation over the next two quarters. And so that’s going to give the Fed the ammunition to start cutting rates, and hopefully that will help employment, and that would help growth as well.”

This article is part of the Advisor To Go program, sponsored by CIBC Asset Management. The article was written without input from the sponsor.