Posted by on October 4, 2017 4:18 pm
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With the race for the next Fed chair in its final stretch as Trump is now expected to make his decision over the next few weeks, and following recent reports from Bloomberg, Politico and the WSJ, the three frontrunners to replace Yellen, according to PredictIt, are Kevin Warsh, Jerome Powell, Gary Cohn and unexpectedly, Neel Kashkari, following yesterday’s endorsement by Jeff Gundlach

… Bank of America has put together a handly cheat sheet laying out a summary of the major views by the 4 key contenders.

Focusing on the top four candidates, BofA, predictably, sees Warsh as the most hawkish and most likely to change the way the Fed conducts monetary policy, leaning toward rules-based policy. BofA also thinks Warsh would favor a lower ultimate size of the balance sheet but would be a strong proponent of deregulation. Meanwhile, Powell is the establishment candidate who won’t ‘rock the boat’ as his stance is consistent with the current framework of the Fed. As for Cohn, he would likely lean a bit more dovish and emphasize putting in place monetary policy to complement fiscal policy reform.

Here is the full breakdown, according to BofA, which shows just how “unconventional” Warsh is in the context of his peers.

With that in mind, BofA’s Michelle Meyer writes that the Trump administration presumably have two main goals when choosing the Fed Chair:

  1. monetary policy to remain accommodative and
  2. financial deregulation.

The ultimate goal is to generate stronger economic growth and prolong the business cycle. This puts Warsh and Cohn in a strong position as both have argued that the right set of monetary and fiscal policy can yield trend 3% GDP growth. However, Warsh may be perceived as more hawkish when it comes to monetary policy.

Below is BofA’s detailed breakdown of the “contestants”:

Contestant #1: Kevin Warsh

Kevin Warsh is a lawyer by trade, who is currently a distinguished visiting fellow at the Hoover Institution and lecturer at Stanford. He was a Fed Governor from 2006 to 2011, which was the heart of the financial crisis. Prior to the Fed, he worked at the National Economic Council under the GW Bush administration and at Morgan Stanley as an investment banker. Since leaving the Federal Reserve, Warsh has published a number of op-eds where he has expressed his frustration with the Fed’s easy policy stance. Below are a few representative quotes from his op-eds and from the Fed transcripts.

Interest rate policy:

  • Jan 2017 op-ed: “What would a well-conceived, rigorously implemented Fed strategy look like? It would be clearly delineated and broadly measurable. Its goals would be within the scope of the Fed’s policy tools, attainable over time and circumstance. Critically, the strategy would be squarely focused on the medium term, that is, the next several years.”
  • “Seeking in the short run to exploit a Phillips curve trade-off between inflation and employment is bound to end badly. …. The Fed should adhere to a concept I would term “trend dependence.” When the broader trends begin to turn-for example, in labor markets or output-the Fed should take account of the new prevailing signal.”

QE and balance sheet normalization:

  • March 2009 on QE: “I am quite uncomfortable with the idea of purchasing long-term Treasuries in size. As the papers described to us, the benefits could well be quite small. My sense is the costs might not be.”
  • April 2009 on QE2: “…I oppose an increase in our Treasury purchases beyond what we did last time. In terms of the discussion about markets and their expectations that we had earlier in this round, Mr. Chairman, I think we should not be surprised that markets want more; and the more we give, the more they will want.”
  • Jan 2010 on B/S exit: “But I would be inclined to push down excess reserves so we can be more effective when we decide we have to make more-meaningful steps to remove policy accommodation. On the question of the long-run balance sheet in the steady state, I think we should “try to go home again.” It is difficult, but I think that we should try to, and I think we should be pretty explicit publicly about that desire. I am concerned about the efficacy of our operating target.”

Fed credibility:

  • Jan 2010: “I think of our preeminent goals here as ensuring our credibility so that: we can increase control and the perception of control over policy rates; we can be perceived to be able to effectively tighten financial conditions; and we can find our way back to a balance sheet and a regime that preceded this crisis.”
  • Nov 2013 op-ed: “Full disclosure of its balance sheet and operations is essential to the Federal Reserve’s democratic legitimacy. But transparency in communications about future policy is not a virtue unto itself. The highest virtue is getting policy right. Given manifest uncertainties about the state of the economy, oversharing policy deliberations is not useful if markets are led astray, or if public commitments reduce policy makers’ flexibility to call things the way they see them.”
  • Jan 2017 op-ed: “Short-term thinking and ad hoc measures by the Fed beget short-term reactions by financial firms, businesses and households. …. The Fed’s technocratic expertise is no substitute for a durable strategy. This make-it-up-as-you-go-along approach causes many Fed members to race to their ideological corners, covering themselves as hawks and doves. It causes economists to litigate a false choice between fixed policy rules and unfettered discretion.

Regulation and fiscal policy:

  • Aug 2016 op-ed: “With the enactment of the Dodd-Frank Act, the Fed claims the mantle of reform. It now micromanages big banks and effectively caps their rate of return. The biggest banks’ growth in market share corresponds to that of their principal regulator. “
  • April 2016: “The U.S. should lead the world in driving a growth-enhancing agenda, and fast. Washington must pursue policies that create new demand, rather than sanction an economic tit-for-tat that merely diverts demand among contesting countries. Supply-side, structural reforms-including radical tax reform and pro-competition regulatory reform-would propel domestic growth, and show the world a better way forward. “
  • Oct 2015 op-ed: “Efforts by the Fed to fill near-term shortfalls in demand through QE and so-called forward guidance have shown limited and diminishing signs of success. And policy makers refuse to tackle structural, supply-side impediments to investment growth, including fundamental tax reform.”

Bottom line on Warsh: If appointed, he is unlikely to immediately change the stance of policy and would continue to call for a gradual increase in interest rates and reduction in the balance sheet. However, the tone of the FOMC will change with Warsh, showing a hesitance to discuss recent data or economic models and instead a focus on influencing medium term growth. We also think Warsh would look to announce a change to Fed communication, potentially adjusting the time period of the dots to remove the focus on near-term policy moves. We also think he would pencil in a higher long-run equilibrium Fed funds rate (R*) and emphasize the desire to return to a “pre-crisis” equilibrium for the balance sheet. The likelihood of the Fed delivering four hikes next year goes up.

Contestant #2: Jerome Powell

Like Warsh, Jerome Powell is a trained lawyer and not an economist. Powell has been a Fed Governor since 2012 and therefore was involved in the decision-making behind QE3 and then policy normalization in recent years. Prior to joining the Board, he was a visiting scholar at the Bipartisan Policy Center, a partner at the Carlyle Group, and worked at the Treasury under the GWH Bush administration. Powell has been a vocal member of the FOMC, giving regular speeches and appearing in the media. Here are the talking points:

Interest rate policy:

  • June 2017: “The Committee has been patient in raising rates, and that patience has paid dividends. While the recent performance of the labor market might warrant a faster pace of tightening, inflation has been below target for five years and has moved up only slowly toward 2 percent, which argues for continued patience, especially if that progress slows or stalls. If the economy performs about as expected, I would view it as appropriate to continue to gradually raise rates.”
  • “In the case of the federal funds rate, the endpoint of that process will occur when our target reaches the long-run neutral rate of interest. Estimates of that rate are subject to significant uncertainty. The median estimate of its level by FOMC participants in March was 3 percent, more than a full percentage point below pre-crisis estimates.”

QE and balance sheet normalization:

  • June 2013: “Most research has found, and I agree, that the first round of purchases of longer-term securities, which began in November 2008, contributed significantly to ending the financial crisis and preventing a much more severe economic contraction. The second round of purchases that began in November 2010 also appears to have been successful in countering disinflationary pressures. Now that the financial crisis has receded and the economy is recovering at a moderate pace, are asset purchases still effective? In my view, the evidence across the channels is mixed, but positive on balance.”
  • June 2017: “To affect financial conditions, the Federal Reserve has therefore used administered rates, including the interest rate paid on excess reserves (IOER) and, more recently, the offering rate of the overnight reverse repurchase agreement (ON RRP) facility. This approach, sometimes referred to as a “floor system,” is simple to operate and has provided good control over the federal funds rate. In November 2016, when the Committee discussed using a floor system as part of its longer-run framework, I was among those who saw such an approach as “likely to be relatively simple and efficient to administer, relatively straightforward to communicate, and effective in enabling interest rate control across a wide range of circumstances.”


  • June 2017: “Our objective should be to set capital and other prudential requirements for large banking firms at a level that protects financial stability and maximizes long-term, through-the-cycle credit availability and economic growth. To accomplish that goal, it is essential that we protect the core elements of these reforms for our most systemic firms in capital and liquidity, stress testing and resolution.” Powell discussed five possible regulatory reforms.
  • “The first is simplification and recalibration of regulation of small and medium-sized banks.
  • “The second area is resolution plans. The Fed and the Federal Deposit Insurance Corporation believe that it is worthwhile to consider extending the cycle for living will submissions from annual to once every two years, and focusing every other of these filings on key topics of interest and material changes from the prior full plan submission.”
  • “Third, the Federal Reserve is reassessing whether the Volcker rule implementing regulation most efficiently achieves its policy objectives… there is room for eliminating or relaxing aspects of the implementing regulation in ways that do not undermine the Volcker rule’s main policy goals.”
  • “Fourth, we will continue to enhance the transparency of stress testing and the Comprehensive Capital Analysis and Review (CCAR).”
  • “Finally, the Federal Reserve is taking a fresh look at the enhanced supplementary leverage ratio. We believe that the leverage ratio is an important backstop to the risk-based capital framework, but that it is important to get the relative calibrations of the leverage ratio and the risk-based capital requirements right.”

Bottom line on Powell: Since joining the Fed, Powell has established a reputation as a centrist on the monetary policy spectrum, aligning his views with that of the consensus. In fact, he often references how the committee thinks (good practice for post-FOMC press conferences). Powell is a pragmatist when it comes to regulation, wanting to retain much of the post-crisis reforms but willing to revisit certain aspects that may have missed the mark, such as the Volcker rule. He would mean continuity at the Fed.

Contestant #3: Gary Cohn

Gary Cohn is the Director of the National Economic Council and Chief Economic Advisor to the Trump administration. He was formerly the COO of Goldman Sachs, having spent most of his career at the investment bank. He is not a trained economist. Cohn has been focused on tax reform but has been rumored to have the Fed Chair goal in mind. Press reports suggested that he was at the top of the list until September 6th when President Trump told reporters that he was “unlikely” to nominate him given a difference of opinions surrounding how the administration handled the Charlottesville event. More recent press reports indicate that he is still in the running. Cohn has not been as vocal on monetary policy as Warsh or Powell, but we put together some relevant commentary.

Monetary policy:

  • April 2015 Bloomberg TV: He believes Yellen should be patient. She presumably has a desire to raise interest rates so that she has the ability to lower interest rates if something went wrong. But on the flip side, the Fed has a dual mandate and there is no sign of inflation in the system. He argues that Yellen may want to intellectually raise interest rates but will not be able to.
  • Jan 2015 Bloomberg TV: He argues that there are currency wars as a result of global central bank policy. The US is just “watching” as other central banks devalue so our currency is appreciating rapidly. He argues that we are in a global economy where the prevailing view is that one of the easiest ways to stimulate economic growth is to have a low currency…which makes sense.
  • Feb 2015 Bloomberg TV: He is not convinced that one good jobs report has changed the outlook. He thinks the Fed is going to be in a tough dilemma – will want to increase interest rates but will be constrained by circumstances and the strength of the dollar. Central bankers tend to need to see real inflation before hiking.

Fiscal policy and regulation:

  • Sept 2017 CNBC interview: Expects the tax plan to bring about an enormous amount of growth. The plan will drive business back to the country and make the US more competitive. He thinks with tax proposal and deregulation, the economy can be “substantially” above 3% GDP growth. Economic growth will pay for the tax cuts.
  • Oct 1, 2017 Fox Business: We started down a regulatory path which was our number one objective. We’re starting to have some wins on regulation. We’ve got a tax path…we’ve got infrastructure to do. The agenda is to drive the economy.
  • Bottom line on Cohn: He would likely lean more dovish on monetary policy, looking to avoid a significant tightening of financial conditions. This means preventing significant dollar strengthening, higher rates or lower equity prices. On fiscal policy, he is clearly on the same page as the Administration with the goal of easing financial market regulation and implementing tax reform in an effort to generate 3%+ growth, which he believes is sustainable. In this respect, we would anticipate that his forecasts would be based on a longer business cycle, therefore implying a higher long-run equilibrium rate (R*).

Contestant #4: Janet Yellen

Current Fed Chair Yellen is also in the running as President Trump has been on the record praising her for her low interest rate policy. She also reportedly has a good working relationship with Treasury Secretary Mnuchin. Moreover, to the extent it matters, it is historic precedent to reappoint the sitting Fed Chair even after a change in the White House. Yellen’s policies are well known: she supports the gradual normalization of rates and the balance sheet. The balance sheet reduction is essentially on auto-pilot now and will continue even in the face of a weakening economy. She supports current financial regulation but has noted that there are policies that can be amended and that she would work with nominee Randy Quarles on adapting current regulatory policies to make them more supportive of fostering economic growth.

Would Yellen accept another term? We think she would. In our view, she would consider her job to be partly done and would like to complete the normalization process. When she accepted President Obama’s nomination, she presumably thought her term would last longer than four years. Moreover, she cares deeply about the integrity of the institution and maintaining independence from Congress, which she would be able to fight for.

* * *

Finally, here is BofA’s “prediction” on who the next Fed chair will be:

It remains a close race. Recent press reports suggest that Warsh and Powell have taken the lead.(*) We can also look to the betting markets: as of October 4rd, PredictIt showed about a 43% probability for both Warsh and Powell.

The reality is that it is still too early to tell and we should prepare for the potential of “dark horse” candidates. Moreover, while the focus is on the Chair spot, the Administration may also announce a nominee for Vice Chair and can work toward filling the additional three vacancies on the board (assuming Randy Quarles is confirmed in short order). The focus is on the Chair – as it should be – but there are several opportunities to influence the direction of Federal Reserve policy. Until there is clarity about Fed leadership, we suspect that market participants will be hesitant to take a strong position on medium term monetary policy.

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