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The Fed risks getting caught up in politics, whatever it does


The problem with being independent of politics is that appearances matter. You don’t have to just be independent, you must also appear to be independent—even if that changes what you might otherwise do.

The problem with being independent of politics is that appearances matter. You don’t have to just be independent, you must also appear to be independent—even if that changes what you might otherwise do.

Many investors think the Federal Reserve might be pushed to do exactly that, lowering interest rates in March to get the rate-cutting cycle started before the election campaigns really get going.

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Many investors think the Federal Reserve might be pushed to do exactly that, lowering interest rates in March to get the rate-cutting cycle started before the election campaigns really get going.

Its desire to avoid political controversy helps explain why traders are still pricing around a 50-50 chance of a March cut, despite stronger than expected jobs and inflation figures and pushback from Fed policymakers against imminent easing.

Suspicion of the Fed’s motives is inevitable: It has great power, but we have to take it on trust that it uses it in the greater interest of the nation, rather than for partisan purposes. Conspiracy theories abound. Resignations in 2021 of two regional Fed leaders after revelations about their stock trading further weakened public confidence, although they were cleared of breaking Fed rules.

At one level, it is odd that anyone thinks the Fed could possibly be free of partisan politics. Its previous head, Janet Yellen, is now President Biden’s Treasury secretary. Lael Brainard, who before joining the Fed was a Treasury undersecretary under Barack Obama, resigned as Fed vice chair to run Biden’s National Economic Council. Fed Chair Jerome Powell is a former undersecretary of the Treasury, for George H.W. Bush. The Treasury isn’t the most partisan part of government, but its leaders are hardly untainted by politics.

At another level, the need to appear to be free of partisanship is obvious. The Fed has done a good job in the past of steering clear—even when President Donald Trump ran a sustained campaign of criticism of Powell and his 2018 rate increases.

“We don’t think about political events,” Powell insisted in December. “We don’t think about politics. We think about what’s the right thing to do for the economy.”

Transcripts of past meetings show that is kind of true. The Fed has spent a lot of time discussing politics in election years—but not, at least according to its public records, because it wanted to influence the result. Instead, uncertainty about elections was discussed as a possible reason for subdued consumer sentiment. The winner mattered as the outcome might have led to euphoric household spending, at least by half the voters. Policymakers also spent time before several past elections worrying that whoever won, politicians would keep spending more than they should. Politics affects the economy, so it has to matter to the Fed.

Fed policy discussions have in the past been directly influenced by election timing. In the run-up to the 1984 re-election of President Ronald Reagan, there was disagreement between New York Fed President Anthony Solomon, who wanted to hold off on easing to avoid looking political, and Chair Paul Volcker. “I’d just play it straight,” Volcker said, according to the Fed’s official transcript. Interest rates went on to fall ahead of the election.

The reason all this matters is that the timing and scale of rate cuts this year is one of the biggest points of debate among investors. If the Fed felt obliged to hold off on rate cuts because of the election, it would disappoint markets and lead to higher bond yields and, most likely, hit stock prices.

Close observers of the Fed are split on how much it matters—but almost everyone agrees that if rate cuts are already under way early in the year, accusations of politicization will have no bite.

“I would be more concerned about politics having an impact if we were debating a September vs. November cut for initiating a rate cycle,” said Jan Hatzius, chief economist at Goldman Sachs. “But I think rate cuts will probably be well under way by then, and if they’re under way I don’t think it’s a significant issue.”

Gary Cohn, who served as director of the National Economic Council during the Trump administration and is currently vice chairman of International Business Machines, focused on the gap between the perception and reality of political influence.

“Will it look political? Does it already look a little political? One could argue that the timing of the pivot meeting already looks a little political,” he said, referring to the moment in December when Powell accepted the possibility of cuts.

But Cohn trusts the Fed to focus on the economy. “If you’re really doing your job as a Fed governor you should ignore the election,” he said.

The danger for the Fed is that in today’s hyperpartisan environment whatever it does can seem to be taking sides. Trump has already broken the convention of politicians not publicly trying to influence the Fed, and his commanding lead in the Republican primary contest presents the possibility he will do so again.

Policymakers will surely be taking care to appear independent—but brace for plenty of discussion among investors about whether they are behaving differently as a result.

Write to James Mackintosh at james.mackintosh@wsj.com

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