By Rodrigo Campos
NEW YORK, Oct 20 (Reuters) - Investors awaiting the
nomination of the next Federal Reserve chair are hoping whoever
is nominated pursues the same monetary policy that has supported
rising stock prices for the past nine years.
Led by Janet Yellen since 2014, the Fed is about to allow
its $4.5 trillion portfolio of securities to shrink, and in late
2015 it began raising interest rates from the low levels seen
after the 2008 financial crisis. A new Fed chair who argues for
tightening monetary policy more aggressively is seen putting
economic growth at risk, along with corporate earnings, and the
long stock market rally.
A faster rise in short-term interest rates would likely
flatten the yield curve, narrowing the gap between short and
long term debt yields, which could crimp bank profits and
strengthen the U.S. dollar, hurting exporters' sales.
U.S. President Donald Trump has selected a pool of five
candidates from which to choose the next Fed chair: current Fed
Chair Janet Yellen; Trump's chief economic adviser, Gary Cohn;
former Fed Governor Kevin Warsh; current Fed Governor Jerome
Powell, and Stanford University economist John Taylor.
Cohn and Powell are the two most likely to follow current
Fed policy, while Taylor and Warsh are seen likely to push for
raising interest rates at a faster clip and to argue for a
quicker run-down in the bond portfolio accumulated after the
Most important to stock investors is the continuation of the
so-called "Fed put", or the expectation of easy monetary policy
as stock prices fall that first came into prominence under
former Fed Chair Alan Greenspan.
For years investors in stocks have assumed the Fed granted
them a put option, effectively providing insurance against a
market fall, by flooding money markets with cash and buying
government bonds to keep interest rates low whenever economic
growth slumped or geopolitical risks rose.
Under Bernanke, the Fed helped to navigate the economy out
of the 2008 financial crisis until 2014 when he was succeeded by
Yellen. During that time the U.S. benchmark S&P 500 stock index
rose nearly 40 percent. Since Yellen took over from him
in February 2014, the index has gained a further 45 percent.
"I think in their hearts every modern Fed chair knows that
the institution's mandate has to include stock prices," said
Nicholas Colas, co-founder at DataTrek Research in New York.
President Trump has praised the record highs in U.S. stock
prices, perhaps making it less likely that he would nominate
someone who would deviate markedly from current Fed policy.
Following is a summary of possible markets reactions to the
nomination of each name in Trump's shortlist (in alphabetical
A Cohn nomination would "be met positively,” said Walter
Todd, chief investment officer at Greenwood Capital Associates
in Greenwood, South Carolina. "The perception is that he is
Cohn is currently director of the White House National
Economic Council and is a former president of investment bank
"If (Cohn) were to reach that position I think the market
would trade the dollar lower and you’d see a steepening of 5-30s
in the U.S. yield curve, because he’d be viewed as having the
biggest impact on inflation expectations moving forward," said
Kay Mirza, global head of FX trading at Goldman Sachs.
A governor on the Federal Reserve board since 2012, Powell
has yet to cast a dissenting vote against the Federal Open
Market Committee's decisions on monetary policy. His appointment
would remove uncertainty and would likely see Fed policy
continue little changed.
"Powell would follow very close to Yellen and would be a
great choice for the market," said Paul Zemsky, chief investment
officer, Multi-Asset Strategies and Solutions at Voya Investment
Management in New York.
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.
Famous for a formulaic approach to monetary policy,
including the so-called Taylor Rule, he is seen as likely to
tighten monetary policy more quickly.
"Taylor would be a negative surprise for the stock market,"
said Voya's Zemsky. "Applying rules-based policy would bring
closer the risk of a recession before the economic expansion
plays out entirely."
His nomination could also boost the U.S. dollar since by his
own formula the Fed Funds rate, now at 1.25 percent, should be
closer to 3.0 percent.
"If you are looking for something disruptive, put Kevin
Warsh at the top of the Fed," said Art Hogan, chief market
strategist at Wunderlich Securities in New York.
Analysts do not think investors have priced in the
probability of a Fed that raises interest rates more quickly and
a Warsh appointment would likely trigger a spike in Treasury
yields, a rise in the dollar and a fall in stocks.
Formerly Bernanke's right-hand man on financial markets,
Warsh quit the Fed in 2011 as he disagreed with the central
bank's second round of bond-buying and is seen unlikely to
pursue a policy path of extraordinary measures if faced with
"The balance sheet reduction program is the key policy tool
for next year," said Lee Ferridge, head of macro strategy for
North America at State Street. "If (stock) markets started to
come off Warsh would be less inclined to change the path.”
Yellen has followed her predecessor's path of data-driven
and market-aware monetary policy and she has been cautious about
generating strong reactions from financial markets by ensuring
policy changes have been well telegraphed ahead of time.
"Yellen... would be the most obviously market-friendly
situation," said Michael Purves, chief global strategist at
Weeden & Co. "The markets understand how she works and there's
Fed's balance sheet v the S&P 500: http://bit.ly/2imIR6B
U.S. Dollar Index v Fed Funds Rate: http://bit.ly/2yAwLwc
Fed Chair & Markets: http://reut.rs/2l3eNhn
(Reporting by Karen Brettell, Caroline Valetkevitch, Megan
Davies, Dion Rabouin, Herb Lash, Lewis Krauskopf and Rodrigo
Campos; editing by Clive McKeef)
© 2017 Thomson Reuters. All rights reserved. Reuters content is the intellectual property of Thomson Reuters or its third party content providers. Any copying, republication or redistribution of Reuters content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters. Thomson Reuters shall not be liable for any errors or delays in content, or for any actions taken in reliance thereon. "Reuters" and the Reuters Logo are trademarks of Thomson Reuters and its affiliated companies.