The 5 Major New Challenges for the Fed in the Coming Months

Inflation will be the most pressing issue in the coming months.

This issue of In Bitcoin We Trust Newsletter is for all subscribers. To get more insights on Bitcoin, you may be interested to upgrade to the premium package.

See the Plans


Joe Biden has just announced his intention to reappoint the current Fed Chairman, Jerome Powell. The Senate should confirm this nomination without difficulty. Jerome Powell, who provided decisive support to the American economy during the COVID-19 pandemic, was almost certain to be reappointed.

Nevertheless, the scandal of the stock market investments of some members of the Fed has damaged his image in America and almost cost him his job. If he is extended, Jerome Powell will be under scrutiny. The appointment of Lael Brainard as Fed vice-chair is a clear sign of this. This left-leaning economist is intended to be President Joe Biden's modern-day asset.

An experienced negotiator, Lael Brainard could be more open about digital currencies as a statement she made in September 2021 suggests:

“If other central banks introduce digital currencies, it would be hard to imagine that America, given the dominance of the U.S. dollar in international payments, would not have a seat at the table.”

Additionally, this could be a solution for the 6% of Americans who remain unbanked in 2021.

That said, Jerome Powell's next term as Fed chair looks to be even more complex than the last. The Fed will indeed have to face 5 new major challenges in the coming months.

1. Cooling the rise in prices

Consumer prices rose by 6.2% year-on-year in October, a jump not seen in thirty years. And even though the Fed favors another index (PCE for Personal Consumption Expenditures) which shows a slightly more limited increase (+4.4% in September over one year, including +3.6% excluding energy and food), the subject has become politically very sensitive in the United States.

Jerome Powell may have been denying the obvious throughout 2021, but inflation is here. In the last few weeks, Jerome Powell's speech has changed to talk about transitional conditions that are leading to very high inflation in America.

The Fed's certainty on inflation has faded over the weeks to the point that Jerome Powell is now talking about the second or third quarter of 2022 for an easing. This could potentially change the way the Fed uses its two main tools: the planned reduction in asset purchases ("tapering") and interest rate hikes. These two tools should enable it to ensure price stability and maximize employment, its two mandates.

The tapering announced at the beginning of November 2021 by the Fed planned to exit this asset purchase program in eight months, via a decrease of 15 billion dollars per month. A possible interest rate hike should only be considered after the end of the tapering. But with prices still likely to rise in the coming months, some economists now believe that the Fed could accelerate its initial schedule.

At the very least for assets linked to the real estate market, since in addition to U.S. Treasury bonds, the Fed is buying mortgages. As for the rate hike, it could happen much faster than initially imagined by Jerome Powell. For example, Goldman Sachs expects the first increase in May 2022, followed by a second in November 2022.

As a reminder, the Fed revised its assessment of price stability last year, indicating that it was aiming for inflation to be permanently anchored around 2% and that it could therefore let prices (PCE index) move slightly above this level for a while.

2. Understanding the new labor market

In addition to ensuring price stability, the Fed must also ensure maximum employment. But the U.S. labor market is difficult to read in this post-COVID period, with behavioral changes that disrupt traditional analyses. Five million people have exited the labor market, and are not looking to return despite the need.

The unemployment rate has fallen faster than expected (to 4.6% in October 2021), but the labor force participation rate (61.6%) has not recovered its pre-crisis level of 63.3% in February 2020.

Anticipating future behavior is therefore essential to measure the degree of overheating in the US economy and calibrate the monetary response. The public statistics of the BLS (Bureau of Labor Statistics) have also underestimated the strength of the labor market in recent months. An additional difficulty, when the Fed has for months given its anointment to a generous fiscal policy to counter the effects of the crisis.

3. Ensuring the Fed's ethics

The U.S. press has uncovered conflicts of interest at best, and insider trading at worst, in the way some Fed officials manage their investments. These revelations led to the resignation of two regional Fed presidents. In addition to an investigation requested from its inspectorate general (the results of which have not yet been published), the Fed board announced new ethical rules at the end of October 2021.

They provide for a stricter framework for personal investments, and in particular that executives, some of whom are very wealthy, will no longer be able to negotiate individual shares.

These rules are to be implemented “in the coming months” according to what the Fed said in October 2021. While the Trump administration had tested the Fed's independence, with presidential injunctions on rate moves, one of the Fed's challenges is to maintain public confidence in the institution.

4. Keeping its role as a regulator

After the financial crisis of 2008, the Fed created a position of governor in charge of banking supervision. Donald Trump was finally the first to appoint an incumbent, Randal Quarles, who will leave the Fed at the end of 2021. This position of vice president in charge of supervision, which some imagined would fall to Lael Brainard, finally appointed vice president of the Fed, will be awarded in early December 2021.

The Fed supervises stress tests and the application of capital and liquidity rules resulting from the Dodd-Frank Act adopted in 2010. In this context, the constraints on medium-sized banks have been eased in recent years. The Fed must coordinate its actions with other financial sector regulators, first and foremost the SEC, where the new chairman, Gary Gensler, has shown his willingness to implement numerous reform projects.

5. Taking the Fed into the future with digital currencies

The Fed is in the midst of a debate over whether to create a digital dollar, but its leaders have mixed views. The appointment of Lael Brainard as vice-chair could accelerate that work:

“The dollar is very dominant in international payments. If the other major global jurisdictions have a digital currency and the U.S. doesn't, I can't wrap my head around that.”

In announcing the reappointment of Jerome Powell as Fed chair, Joe Biden also mentioned the climate issue as a major theme for Jerome Powell and Lael Brainard over the next four years:

“Together, they also share my deep conviction that urgent action is needed to address the economic risks posed by climate change.”

Final Thoughts

In a difficult economic environment, with inflation expected to remain high for many months in America, the Fed will have its work cut out for it in terms of monetary policy in the months to come. There is no shortage of challenges, including the need to adopt a more modern approach with the potential creation of a digital currency.

As an investor, whether in the stock or cryptocurrency markets, it is essential to stay tuned to what the Fed is saying, as it sets the trend in the financial markets.


Some reading