Jeffrey Schmid, President of the Federal Reserve Bank of Kansas City, said the Federal Reserve has layers of independence. Speaking at the Economic Club of Colorado, he said politics do not enter policy debates and linked independence to better decisions.
He described Jerome Powell as a patriot focused on doing what is right for the nation. He said each Fed chair has their own approach to running the Federal Open Market Committee (FOMC), and last year’s FOMC dissents were not made lightly.
Inflation Still Not Conquered
Schmid said the Fed would not return to the balance sheet size seen before the financial crisis. He said the main balance sheet debate is about the size of reserves, and he raised concern about the duration of the balance sheet.
He said the Fed’s mortgage holdings have lowered yields in that market. He added it will take years for the Fed to run off its mortgage bond holdings, while Treasury bill buying for reserve management is relatively modest.
Schmid said more work is needed on the inflation side of the Fed’s mandate. He said the job market is in a pretty good place, and the Fed is attentive to, but not preoccupied by, markets.
Schmid said any Fed response to market trouble would depend on the cause. He also said he appreciates that Kevin Warsh, if confirmed as Fed chair, would bring experience.
Trading Implications For A Higher Rate Path
We still have work to do on the inflation side of the mandate, and traders should take this seriously. The latest CPI reading for January came in at a sticky 2.9%, showing that the final push to the 2% target remains difficult. This suggests that options pricing should favor a “higher for longer” interest rate scenario, as the path to rate cuts is not clear.
The job market is in a pretty good place, giving the central bank cover to maintain its current stance. With unemployment at 4.1% and last month’s payrolls adding a solid 190,000 jobs, there is little pressure to ease policy to support employment. Traders should therefore be cautious about betting on rate cuts based on any minor labor market weakness.
We are never returning to the balance sheet size seen before the financial crisis, making the main debate about the level of reserves. The Fed’s holdings are still hovering just over $6 trillion, and the runoff of mortgage bonds will take years, just as we thought back in 2025. This creates a predictable, long-term tightening effect, which could continue to put a subtle drag on long-duration assets.
We should remember that the central bank is attentive to, but not preoccupied by, the market. This means volatility strategies, like buying VIX call options or straddles, could be effective as the Fed is unlikely to step in and quell market swings unless they threaten systemic stability. This is a very different environment than the post-2020 era, a shift we started to fully price in during the middle of last year.
The insistence on independence from politics means we should trust the data over any political chatter. This reinforces a strategy of focusing on key economic releases like inflation and employment reports. Betting on a policy change based on political pressure is likely a losing trade.
