Fed decision day is coming. Not the Federal Open Market Committee (FOMC) decision (although that one is coming November 1). No, we're talking about THE decision, which will make the policy decisions at future FOMC meetings all the more riveting for the capital markets.
THE decision we are referring to is going to be made by President Trump and it involves selecting an individual to be the next Chairman of the Federal Reserve Board of Governors.
It is possible that the next person is the current person. Janet Yellen's term as Fed Chairman ends on February 3, 2018, yet her reappointment is in question.
Soon enough, the president will be providing everyone with an answer as to whether Ms. Yellen will get the opportunity to take another turn as Fed chair or be forced to cede that post to another individual.
THE decision, according to news reports, is expected to be made sometime before the president departs on November 3 for an 11-day trip to Asia and Hawaii.
Other than Ms. Yellen, leading candidates include Fed Governor Jerome Powell, former Fed Governor Kevin Warsh, National Economic Council Director Gary Cohn, and Stanford University economist John Taylor whose eponymous Taylor Rule has been praised and derided through the years as a potential guideline for setting monetary policy.
Place Your Bets
The five individuals named above are touted as leading candidates because the president himself has said that his nominee will probably come from that list. The door, though, remains cracked open for a dark-horse candidate to emerge.
Minneapolis Fed President Neel Kashkari and Columbia Business School Dean, Glenn Hubbard, who was also chairman of the U.S. Council of Economic Advisers, are among the more widely-cited names in the dark-horse mix.
Naturally, there is a vortex of opinions on whom should get the nomination and why.
With betting markets as our guide, it would appear that Jerome Powell is the horse to beat. PredictIt (www.predictit.org) shows a 52% probability of Powell winning the nomination followed by John Taylor at 18%, Kevin Warsh at 15%, Janet Yellen at 13%, and Gary Cohn at 6%.
Bettors are assigning a very low probability of 2% for Neel Kashkari and just 1% for Glenn Hubbard.
All the Buzz
There is no question that capital markets will be buzzing when the nominee is announced. We should be able to tell pretty soon in the price action, too, whether market participants think the nominee is market friendly.
We would caution against making too much of knee-jerk reactions because, just as the president has learned, it is a lot easier to govern as a candidate than it is as the president. In the same vein, dynamic economic conditions and geopolitical happenings should make it clear to any Fed chair that hardline views are easier to express when they are not in the policy-setting chair.
John Taylor may be the only exception to that thinking since his approach to managing monetary policy would presumably be rules-based, meaning it would be less reliant on qualitative analysis.
That offers us a good segue into a brief, Pro/Con synopsis for each candidate.
- Markets are familiar with her thinking
- Viewed as a dove
- Has the right professional pedigree to oversee the balance sheet normalization process
- A number of Senate GOP members have criticized her monetary policy approach
- Doesn't share the same deregulation fever the president does
- A member of the Board of Governors since 2012, so stands out as another continuity candidate
- Reportedly favored by Treasury Secretary Mnuchin
- Considered more of a policy centrist, which could make nomination easier
- Sounds more amenable to financial sector deregulation than Fed chair Yellen does
- Mnuchin reportedly said he feels like he could exert more control over Mr. Powell, which raises questions about Fed's political independence
- While relatively young, has good experience working at the Fed
- Understands Wall Street
- Father is friend of President Trump
- Has been critical of Fed policy, earning himself a hawkish label that could run afoul of the president's fondness for low interest rates
- His appointment could leave the president exposed to allegations of cronyism that might make the nomination process more challenging
- Is an economist with an academic background that many think is a proper background for a Fed chairman
- Rules-based approach has won him accolades from some Senate GOP members opposed to the Fed's non rules-based approach to managing monetary policy
- Taylor Rule would call for higher policy rate than currently exists, which has earned him the label of being a hawk
- Rules-based approach seen by some as too rigid for managing monetary policy given the dynamism of capital markets and the global economy
- Understands Wall Street
- Would potentially be more deliberate about raising the policy rate so as not to choke off economic recovery effort
- No Fed experience
- Undivided attention still needed on tax reform effort
- Reportedly hurt his chances with his criticism of the president's remarks in Charlottesvile
What It All Means
What we know is that President Trump has said he favors low interest rates and financial sector deregulation. We also know the president is fond of acknowledging the stock market's performance as an affirmation of his administration's policies.
The persistence of low interest rates of course has been a key driver of the bull market and multiple expansion.
The stock market can tolerate gradually rising interest rates that coincide with an improving economy and rising earnings prospects, yet a rapid pace of interest rate increases would be troublesome, especially if they are being paced by a belief the Federal Reserve is behind the curve in fighting inflation.
We think the stock market would love it if Janet Yellen was reappointed, although it looks resigned to the idea that she won't get the nod because she doesn't appear to be as keen on financial sector deregulation as the president is.
The remaining candidates have their share of strengths and weaknesses in the market's eyes, yet we would concede that, if Janet Yellen isn't the pick, Jerome Powell is the one candidate that threads a good needle for both the market and the president.
Powell provides that sense of continuity the market likes; he's a centrist; he's okay pursuing some deregulation for the financial sector; and he should move through the Senate's nominating process relatively smoothly.
What we think, though, doesn't matter. What matters is what the president thinks, what the Senate thinks, since it ultimately blesses the nominee who will serve a four-year term as Chairman of the Federal Reserve Board of Governors, and what the market thinks.
Stay closely tuned. THE decision is coming soon and it's a big one for the president, the capital markets, and the global economy.