The Big Idea

The Federal Reserve and elections

Stephen Stanley | February 23, 2024

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Even though the Federal Reserve is an independent central bank, monetary policy matters to elected officials. And that makes the Fed, to a degree, subject to the election calendar.  Financial market participants lately have spent much time and energy speculating about how the election will affect the timing and magnitude of rate cuts this year.  In my view, the November elections will have a limited impact on the conduct of monetary policy, but they may become relevant in late summer and early fall as we reach the height of campaign season, leading the Fed on stay on hold until the ballots are cast.

Three rules of central banking

There are many different possible monetary policy strategies, and some may even be as good or better than the approaches carried out. But since we are predicting what the Fed will actually do, it pays to understand what the Fed’s preferences are.

The Law of Inertia. I would characterize the Fed’s comfort zone as consisting of three key elements.  First, to paraphrase Newton’s First Law of Motion, the Law of Inertia: a central bank at rest will remain at rest, and a central bank in motion will continue moving with a constant velocity, unless acted upon by an external force.

No quick reversals. The second key point is that the Fed hates, above all, to be forced to reverse direction with its rate moves in quick succession unless there is an obvious shock that warrants an about face.  Several Fed officials have explicitly noted recently that their worst case would be to begin easing and then be forced to reverse course after inflation reaccelerates.

Lean against the biggest risk. Finally, the Fed tends to identify the biggest risk that it faces and to lean against it.  For example, after the Global Financial Crisis, when the policy rate was pinned at the zero bound, the FOMC was inclined to keep policy easier for longer than its standard models suggested because officials were concerned about what might happen if the economy weakened and required further monetary stimulus when the Fed had limited ammunition to boost activity.  Conversely, in the current period, the Fed has identified its biggest risk as not finishing the job of bringing inflation under control and appears willing to maintain restrictive policy longer than standard models would call for.

The combination of these three rules provides some structure to Fed behavior.  Policymakers are often slow to get started on a new cycle of rate moves, because they do not want to move prematurely and find themselves needing to reverse field, which would create unnecessary market volatility as well as making the FOMC look like it made a mistake.  Then, once the Fed gets started, it has usually tended to implement a series of moves in the same direction.

This set of guidelines rules out a popular hypothesis in financial markets entering the year.  Many investors and traders were willing to bet that the Fed would ease several times early in the year and then go into hibernation by the summer to avoid the election season.  While this theory may be intellectually appealing, it runs counter to the Fed’s preferences and is therefore implausible.  In fact, it could be argued that the FOMC has never behaved in this manner.

Election-year history

A brief survey of Fed rate moves in past election years may also be helpful in establishing patterns of behavior.  Nine episodes since 1988 argue for a consistent pattern:

• The Fed is certainly not afraid to make policy changes in an election year. We have seen hikes and cuts at various times in election years.
• However, the FOMC tends to be less active in the immediate run-up to the election. There were only two instances in these nine episodes when the FOMC made a move after Labor Day, about two months prior to the election: 1994, when a well-telegraphed series of hikes began in June and was carried forward on essentially automatic pilot, and 2008, when the financial system was falling apart.
• In 1988 and 2016, the Fed resumed rate hikes soon after the election.

As for the particulars, I will start with the 1988 election, following the logic of FOMC Governor Jefferson’s speech on Thursday that the Fed only began to implement rate moves in discrete increments in the late 1980s.

1988: Monetary policy in 1988 was mostly governed by what had happened the year before.  The stock market crash of October 1987 forced the Fed, under the leadership of new Chairman Alan Greenspan, to reverse field and cut rates to support the financial system and the economy.  Those actions helped to stabilize financial conditions, and, by March 1988, the economy and stocks had recovered sufficiently to convince the Fed to go back to its tightening stance.

Indeed, since the economy had shown no substantial lasting negative impact from the 1987 stock market crash, the Fed found itself with an inappropriately easy policy stance and played catch-up for the next year.  From March 1988 through early August, the FOMC raised rates seven times, by a total of over 100 bp.  After raising rates on August 9, 1988, the Fed went quiet for more than three months.  Then, on November 22, two weeks after election day, the FOMC resumed its tightening campaign, raising rates another five times over the next three months.

1992: A recession in 1990 that was exacerbated by the oil shock driven by the Iraqi invasion of Kuwait led the FOMC to aggressively lower rates throughout 1991.  The subsequent economic recovery proved anemic, so that the Fed continued to lower rates through most of 1992, cutting three more times, with the last move coming on September 4, 1992, the day of the August employment report.  After that, the Fed stayed on hold at a 3% fed funds rate for 17 months before finally beginning to raise rates.

1996: 1996 was a much quieter election year for the Fed.  The famed soft landing of 1995 allowed the FOMC to cut rates three times, beginning in July 1995.  The last rate cut of that cycle occurred in January 1996, after which the Fed was on hold for over a year until March 1997.

2000: Similar to the 1987 episode, the Fed reacted quickly to the Russian debt and LTCM defaults in the fall of 1998 by cutting rates, this time by 75 bp.  The Fed was slow to recognize that the economic fallout from this period of financial turmoil was minimal, and found itself in 1999, as it had in 1988, with an inappropriately easy policy stance at a time when the tech stock bubble was rapidly inflating and the economy was at risk of overheating.  The FOMC began hiking rates in June 1999 and continued to do so through May 2000.  In all, there were three rate hikes in 2000, with the last occurring on May 16, nearly six months before the election.  The stock market and economy eventually succumbed to restrictive policy, and the Fed began to ease in January 2001.

2004: That easing cycle eventually continued all the way into 2003, followed by an extended period of inaction.  Finally, in June 2004, the Fed began a series of “measured” quarter-point rate increases.  The FOMC hiked by 25 bp at 17 consecutive meetings, raising rates steadily right through the election and all the way to mid-2006.

2008: I trust that I do not need to go into too much detail about what happened in the fall of 2008.  The global economy and financial system were melting down.  The Fed had already been cutting rates early in the year, easing three times in the first four months of the year and then going on hold, as inflation fears weighed against financial market turmoil.  The situation became explosive in October 2008, forcing two 50 basis point rate cuts in October (and an eventual move to the zero bound in December).

2012: The Fed was stuck at the zero bound throughout 2012, though it did conduct quantitative easing and strengthened dovish forward guidance over the course of the year.

2016: The FOMC finally moved off the zero bound in December 2015.  Entering 2016, the consensus was that the Fed would probably hike rates three or four times over the course of the year.  As it turns out, global volatility, mostly coming out of China, and low inflation kept the Fed on the sidelines for most of the year.  The second rate hike of that cycle did not come until December 2016, over a month after the election.

2020: This year was dominated by the global pandemic.  The FOMC cut rates to the zero bound in March and left them there until 2022.

Implications for 2024

My interpretation of the Fed’s thinking as it relates to elections is that it will seek to avoid allowing politics to drive its decision-making process.  In general, the Fed will simply do what the economy dictates, especially when the case for a course of action is compelling (such as in 2008).

However, in quieter times, when the proper policy stance is more debatable, the Fed has the luxury of picking its spots.  A quarter-point here or there or making a move six weeks earlier or later in such an environment is unlikely to drastically alter the course of the economy.  This gives the Fed a certain margin of discretion, and I suspect that policymaking in 2024 will fall under that framework.

While the primary mandate for the Fed is to do what the economy requires, a secondary goal would be to avoid becoming a campaign issue in a presidential race.  My sense is that Fed officials in general would prefer to avoid making headlines during the period when candidates are campaigning heavily and the public is dialed in to the race.  Traditionally, this covers the stretch from Labor Day—or perhaps extending back further to August—to Election Day.

I believe there are two plausible scenarios for how monetary policy could play out during this election year.  A version of 1994 is possible.  If the Fed begins cutting rates by mid-year and signals a series of steady rate moves, it could carry on with quarter-point cuts right through the election.  My sense is that the third or fourth or fifth rate move in a cycle would not create the degree of media attention that the Fed would be seeking to avoid.

However, if the economic data drive the Fed to remain on hold into the summer, then initiating a new rate cycle in close proximity to the election becomes problematic.  In my view, a first rate cut at the September 17-18 FOMC meeting is out of the question in the absence of a drastic turn in the economy.  The July 30-31 FOMC meeting is probably fair game, but even that timeframe would likely dictate a somewhat elevated hurdle to launching an easing cycle.

Since I look for the economy and the labor markets to perform better than generally expected in the first half of the year and for inflation to prove somewhat stickier than anticipated, I believe that the Fed will need to remain on hold, purely on the economic merits, at least well past mid-year.  Therefore, I look for the FOMC to remain on the sidelines through Election Day.

As it happens, the November FOMC meeting falls during the same week as the election.  The Fed moved the meeting back by a day to Wednesday and Thursday, creating one additional day of separation from the election.  Assuming that the presidential race has a clear winner on election night, I see the FOMC as free to start a new easing cycle at the November FOMC meeting, as the political ramifications of making a high-profile move after the election, at which point the candidates are no longer campaigning and the Fed cannot plausibly be accused of attempting to sway the vote, are far less than during the heat of the election season.