Happy Birthday, Mr. Powell

First the good news: The economy is experiencing a period of robust growth not seen since before the financial crisis; unemployment is trending towards levels unheard of since the 1960s; and your policy track is pretty well laid for you. Powell’s job, in other words, is to keep it on the rails.

But it’s not all gravy on this train. Stacked among your presents are more than a few jack-in-the-boxes that could pop up at any moment, frightening you, financial markets, and the American and world economies: The unwinding of the Fed’s balance sheet, weighted by $4.2 trillion in assets acquired during emergency purchases during the crisis; Potential drivers of inflation emanating from multiple sources and threatening to combine; Not to mention the man who put you in the seat you’re about to occupy. Tomorrow doesn’t quite appear to be such a gift anymore.

But as much as those challenges are challenges, those gifts are gifts. The US economy is in a state of robust expansion and growth with GDP having risen 3.2 percent in the third-quarter of 2017 from the same period a year before. Unemployment has fallen to 4.1 percent with the pace of decrease on target to reach 3.5 percent this year, a level not seen since Richard Nixon was still in his first term. A reluctant supporter of the Fed’s quantitative easing program of bond purchases upon joining the Fed Board of Governors in 2012, Powell has since become a proponent of the policies enacted by his predecessors Yellen and Ben Bernanke. As such he is largely expected to continue the program of gradual interest rate rises and unwinding of the Fed’s balance sheet they began. But therein lies the first of his issues.

The Fed’s balance sheet is large, extremely large. $2.4 trillion in U.S. Treasury bonds and $1.7 trillion in mortgage-backed securities sit on its books; leftovers from three rounds of quantitative easing that began in 2008. Markets have largely been muted in their reaction to the Fed’s open telegraphing that it will begin trimming its holdings. Having begun the process in September 2017, the Fed is gradually increasing the monthly amount it trims, with $10 billion in assets allowed to roll off each month at first, gradually increasing to $50 billion each month in the final stage of a program that will take years to complete. As this process continues and increases in amplitude, interest rates will be pushed upwards as the price of the bonds fall due to their increasing availability on open markets. Combine this with the three quarter-point increases in the Fed’s benchmark interest rate scheduled for 2018 – bringing the benchmark to 2.25 percent – and you have all the deliverables needed to bring Fed policy back to pre-crisis orthodoxy in the next few years.

But smooth sailing is far from assured. In 2013 when the Fed similarly telegraphed that it would curtail bond purchases, market interest rates rose dramatically in the so called “Taper Tantrum”, causing tumult in an already tense atmosphere as the global economy exited the crisis. Unfamiliarity going forward in 2018 with what such a large sell-off of Fed balance sheet assets means, let alone combined with successive benchmark rate rises, has some market observers concerned that effects could be more pronounced and indeed more volatile than expected. Throw in the fact that China has announced it will curtail or even stop purchases of US Treasury bonds, and potential for larger than forecast market interest rate increases becomes more realistic.

Compounding this issue is the beginning reemergence of inflation. The Fed’s preferred core-inflation measure (excluding food and energy prices) has been below its 2 percent target for seven of the last ten years. But there is evidence that indicates the trend is ending and its demise is being driven from multiple sources in the U.S. and global economies. Rising rent and healthcare costs in 2017 served to push year-on-year core inflation up from 1.7 percent in November to 1.8 percent in December. With the infusion of cash into the economy created by the tax-cut legislation passed in December, the combination has added more fuel to the consumption driven engine of the American economy with consumer spending increasing by 2.2% in the third-quarter of 2017 versus the same period the year before. And that gift of low unemployment Powell will be receiving? Well it might not turn out to be much of a gift after all. With the U.S. labor market tightening, employers are seeking to entice workers from other companies to jump ship with better pay, or coax those sitting on the sidelines of the labor market to enter the ranks of the employed with higher starting wages. Wages increased 2.5 percent in the year up to December 2017, raising the specter of rising prices for labor transmitting into increased prices for products and services. Turning to the global economy, a boom in the output of factories across the globe has led to a spike in demand for commodities, increasing the prices of oil, corn, and everything in between.

What of the Fed’s primary tool for combatting inflation and cooling the economy? The aforementioned three interest rate rises scheduled for 2018 could increase to four depending on the consensus that emerges among the members of the Federal Open Market Committee. These are a double-edged sword however. The same interest rate increases that could cool the engine of the economy if dripped in delicately could also crack it if thrown on like a bucket of cold water. The danger is in overreaction. If the FOMC adds a fourth quarter-point rate increase to its schedule for 2018 or speeds the pace of balance sheet unwinding in an effort to raise interest rates, markets’ adverse reactions might take place so quickly that the Fed could be left without time or the policy space necessary to stop a recession that may suddenly appear on the horizon. This scenario is unlikely given the prudence evinced by the Fed in the past few years, but serves as a point of caution.

Finally, as always, there’s Donald Trump. For a man such as he, who venerates deal-making, independence of anything or anyone is up for barter. Having expressed his preference for low interest rates, and questioned the nature of the Fed and its chairperson as apolitical institutions, independence of the Fed and Jerome Powell—nominated as he was by Trump—seem something the president may consider open for discussion. Fortunately it appears Powell has staunched that possibility already, declaring in his confirmation hearing opening statement to the Senate Banking Committee that he was committed to “preserving the [Fed’s] independent and nonpartisan status,” while “retain[ing] the flexibility to adjust [Fed] policies in response to economic developments.” Despite the many challenges he will face, we can take solace that the man now at the helm of our nation’s economy will be giving us a gift, and acting in the best interest of all Americans.

Brian Wemple holds an MA in International Affairs from American University’s School of International Service with specializations in U.S. Foreign Policy and National Security, and International Economic Relations.