Markets brace for a shakeup at the top of the Fed — Deutsche Bank economists

Let the guessing games begin.

With two seats on the seven-member Federal Reserve board of governors up for grabs, and a third opening up in April, the markets are already beginning to speculate as to who could fill those seats — and, more importantly, who President Donald Trump might tap to serve as the Fed chair when current occupant Janet Yellen’s term ends next year.

“(I)t is possible that five members of the board will be Trump appointees in less than eighteen months’ time,” particularly if Ms Yellen and Stanley Fischer, the Fed’s current vice-chair, step down when their terms end next year, according to Deutsche Bank economists Peter Hooper, Michael Spencer, Torsten Slok and Matthew Luzzetti.

Given his propensity to choose nominees outside the typical political and policy-making circles, Mr Trump’s choices will not only be influential, they could also be unanticipated, possibly leading to wild market swings as investors race to understand the nominee’s positions and price in those expectations.

The report points to the market fluctuations surrounding the replacement of former Fed chair Ben Bernanke. When the markets saw Larry Summers as the likely pick, Treasury yields rose, as he was considered the more hawkish choice with more cautious views about unconventional balance-sheet policies. When his star started to dim and Ms Yellen’s was on the rise, the reaction receded.

Whoever the chair is, they might also put an end to the current trend of a more cautious, consensus-seeking Fed, the report said. There have been an unusually low number of dissenting votes over the past few years, which could change depending on who Trump’s nominees will be.

“Looking ahead, less consensus and more dissent would seem likely if there is a shift away from the centre at the top of the Fed leadership, especially if some of the centrists now in office remain until their terms run out (in most cases not until well into the 2020s),” the report said.

So — who’s it going to be? The report said that Mr Trump may be eyeing a market practitioner, as opposed to an academic economist; someone not too hawkish, lest their policies impede Mr Trump’s growth agenda; and someone who does not buck against the idea of greater congressional oversight at the central bank.

Here are some names that could fit the bill according to the folks at DB:

• Kevin Warsh – currently a visiting fellow at the Hoover Institution, he served on the Board of Governors from 2006 until 2011. The report described him as “an experienced private financial market practitioner with strong Republican credentials”.
• Jerome Powell – a current Fed governor “viewed as having conventional/centrist views about the economy and markets with slightly hawkish leanings”.
• John Taylor – an economics professor at Stanford whose views “would fit with Republican views for a more rules-based Fed.” But, the report added, “his policy leanings — more aggressive rate increases and the stronger dollar that would result — would work against Trump’s pro-growth agenda.”
• John Cochrane – another professor, from the University of Chicago with conservative leanings, whose “recent research has delved into more unorthodox topics, such as whether Fed policy rates and inflation could be positively related, i.e., that low policy rates may lead to low inflation and vice versa.”