by Jesse Cohen
With the Federal Reserve widely expected to raise interest rates in December for the third time this year, market players are looking to see who will replace Janet Yellen as Fed Chairperson when her term expires in February. U.S. President Donald Trump has selected a pool of five candidates: Stanford University economist John Taylor, current Fed Governor Jerome Powell, current Fed Chair Janet Yellen, as well as Trump's chief economic adviser, Gary Cohn and former Fed Governor Kevin Warsh, though the first three appear to be the front runners while the chances of the last two have slipped in recent days.
Indeed, Powell and Taylor have increasingly been seen as the leading contenders for the job, with Trump saying last week that he was considering appointing both to serve in top posts at the U.S. central bank. Under that scenario, either Powell or Taylor would take the reins from Yellen when her term expires early next year, and the other would fill the vice chair position left vacant when Stanley Fischer retired earlier this month.
And as if markets needed yet more uncertainty on the subject, yesterday, during lunch with the Senate's GOP caucus, the President informally polled the group regarding whether they'd prefer Powell or Taylor. According to Senator Tim Scott of South Carolina, "I think Taylor won, but he did not announce a winner." Others weren't so sure: "I couldn't tell which way he was going," said John Kennedy, the junior Senator from Louisiana.
No matter who Trump chooses, we're sure to see a strong reaction across the stock, bond and currency markets. Below is a guide to how markets are likely to react to Trump's Fed chief nomination, beginning from the most hawkish outcome to the most dovish.
John Taylor
Taylor, 70, is currently a Senior Fellow at Stanford University's Hoover Institution.
His prior experience includes roles as Undersecretary of Treasury for international affairs from 2001 to 2005 in the George W. Bush administration as well as member of Council of Economic Advisers under presidents Jimmy Carter and George H. W. Bush.
Taylor is known as a proponent of rule-based monetary policy, which serves as a guideline for how central banks should set their benchmark rates in order to achieve both their short-term economic growth goals and their long-term aim of price stability. According to his formula, known as the 'Taylor Rule', the Fed Funds Rate should be in a range between 3.75%-4%, compared to the current target of 1%-1.25%.
He's regarded by market watchers as the most hawkish of the five candidates and his nomination could usher in a period of higher U.S. interest rates combined with a quicker reduction of the Fed's balance sheet.
Likely market reaction
If Taylor is Trump's choice, the most noticeable reaction will likely be felt in the bond market. Treasurys will sell off sharply, sending yields spiking violently higher as traders begin to price in a more rapid pace of Fed rate hikes.
The sharp sell-off in the bond market will weigh heavily on risk sentiment and dampen appetite for stocks, resulting in a sharp correction for the major Wall Street benchmarks. Taylor's nomination will boost the US dollar given the notion that the Fed Funds Rate will be much higher under his watch.
Kevin Warsh
Warsh, 47, has both a Wall Street and government background. He served as a Fed governor from 2006 to 2011. Prior to that he was an economic adviser to President George W. Bush from 2002 to 2006. He also worked for Morgan Stanley as an M&A lawyer for seven years from 1995 to 2002.
Warsh is viewed by the market as hawkish and has previously stated that the Fed should aim for inflation between 1%-and-2%, effectively lowering its inflation target. He quit the Fed in 2011 when he disagreed with the central bank's second round of quantitative easing and is seen unlikely to pursue a policy path of extraordinary measures if faced with another crisis.
Likely market reaction
Warsh's hawkish views on inflation would likely trigger a short-term spike in Treasury yields and the dollar, while producing a mildly negative reaction among stock traders, as investors factor in faster interest rates, but to a lower end-point.
Gary Cohn
Cohn, 57, is currently director of the White House National Economic Council and is a former president of investment bank Goldman Sachs, where he worked from 2006 to 2017.
Cohn's current job position has given him little reason to comment on monetary policy, but he has worried in the past that the Fed has been "constrained" by the actions of other central banks trying to keep their currencies weak. He would most likely follow current Fed policy but with a slightly more hawkish tilt.
Likely market reaction
Cohn's nomination would be met positively by the stock market, where Wall Street players view him as market-friendly. In the bond market, the gap between short and long-term debt yields would narrow due to an increase in inflation expectations, which would push the dollar higher.
Jerome Powell
Powell, 64, has served as a Fed Governor since 2012, when he was appointed by President Barack Obama, and is widely considered as the Republican Party’s alternative to renominating Janet Yellen.
Prior to serving at the Fed, Powell was a Senior Treasury official under George H.W. Bush. He also has experience working in the private sector, where he was a partner in private equity firm Carlyle Group from 1997-2005.
Powell has never cast a dissenting vote against the Federal Open Market Committee's decisions on monetary policy since joining in '12, and in line with Yellen supports gradually raising interest rates as long as the economy continues growing and inflation is expected to rise.
Importantly, Powell is seen as unafraid of reversing the current plan to wind down the Fed's $4.5 trillion balance sheet if the economic or market outlook changed.
He is considered on Wall Street as a rules-and-regulations guy and has advocated easing some aspects of the Dodd-Frank regulations as well as discussing ways to revise the Volcker Rule.
Powell is widely viewed as the least hawkish candidate—apart from Janet Yellen—compared to his peers on the shortlist.
Likely market reaction
Powell's nomination is unlikely to rock markets as he is seen as the safe bet and one who would not veer much from current Fed policy.
News of his nomination will probably send buyers into stocks and bonds due to the view that he would follow the Fed's current dovish policy stance, while weighing on the dollar.
Janet Yellen
Yellen, 71, has been the head of the Federal Reserve since taking over for Ben Bernanke in February 2014. She also served as a Fed governor, President of the San Francisco Fed, and the Fed's vice chair from 2010 to 2014.
Led by Yellen, the Fed in late 2015 began raising interest rates from the low levels seen after the 2008 financial crisis and recently announced a decision to allow its $4.5 trillion portfolio of securities to shrink. She has been cautious about generating strong reactions from financial markets by ensuring policy changes have been well telegraphed ahead of time.
Likely market reaction
A Yellen nomination would be the most obviously market-friendly outcome as traders and investors are already familiar with how she works and there is less guesswork.
When Might Trump Reveal His Pick?
Trump is expected to make his decision 'very shortly' according to people familiar with the matter. Indeed, on Monday he said the decision was "very, very close." Expectations are that at the latest the announcement will occur by November 3rd, when the President embarks on his tour of Asia.
According to PredictIt, a prediction market that offers prediction exchanges on political and financial events, Powell leads the race for Fed chair, with Taylor and Yellen closing in behind him.
No matter the outcome, stock, bond and currency traders will be busy handicapping the outcome, positioning themselves for the decision in the days ahead, as they look to take advantage of wild swings in volatility.