Why the Search for the Fed chair Matters for the Markets

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As the Trump administration works on deciding whether Janet Yellen, the Federal Reserve Chair, will maintain her post or be replaced, the ordinary investor could feel the result of the decision should the president decide to appoint a new chair.

In the middle of a report on Friday morning that President Trump met with the former governor of the Federal Reserve and Morgan Stanley executive Kevin Warsh, who was earlier rumoured to be a candidate for the post, stocks dropped slightly before recovering.

However, the more notable reaction was in the bond market. Treasury bonds experienced a considerable sell-off, and yields increased, ending higher on the session. This sort of activity would possibly continue if Warsh were appointed, stated the head of global macro strategy at ACG Analytics, Larry McDonald.

“Investors could feel the impact of higher interest rates, as right now there is a very high probability of an interest rate shock impacting stocks,” said Mcdonald.

“We think the market is extremely vulnerable to an interest rate shock. … [if the Fed takes] the punch bowl away, stocks can drop 5 to 10 percent pretty easily,” Mcdonald added on Friday on “Trading Nation,” referring to the accommodative monetary policy’s “punch bowl.”

More granularly, he said that bonds would possibly see further downside, as Warsh is regarded as more hawkish than dovish. This could probably raise bond yields and damage equities.

Reportedly, Warsh has friendly ties with Trump already, as his businessman father-in-law is apparently close to the president.

On Friday, it was also reported by Dow Jones that Trump also met with Jerome “Jay” Powell, the former Fed governor in recent days regarding the position, even though he is not regarded as a front-running contender, according to judgments on the PredictIt platform.

In a report to clients on Friday afternoon which is titled “Fed chair search heats up,” Deutsche Bank economists Matthew Luzzetti and Peter Hooper analysed various outcomes for Fed chair. They wrote that the reappointment of Yellen would “clearly be the one with least disruption to the markets — four more years of the Fed being led under very effective Yellen stewardship.”

The authors wrote that Warsh is “perhaps the most interesting” candidate that is said to be under consideration.

While in the private sector, Warsh has “not shied from being openly critical of the Fed. His criticisms are often nuanced, making it difficult to draw direct implications for how monetary policy could be different under his leadership, but our sense is that he would come down on the hawkish side of the current leadership,” wrote the authors.

The candidates that they consider to have the most realistic possibility of being appointed (or reappointed) “suggest the Fed is not likely to be moving significantly in a more dovish direction.”