Powell Versus Warsh
The movement in the betting market for who will be the next Fed chair was sharp on Tuesday as news leaks out about who President Trump is considering. I’ve long been high on Warsh being picked and pessimistic on Cohn and Yellen’s odds. That perspective has proven to be accurate as on Tuesday Cohn’s odds fell from 16% to 2%. Cohn has no monetary policy experience and criticized President Trump’s handling of the Charlottesville riots. It seemed like a no brainer that he wouldn’t be picked. However, it took until Tuesday for the Predict It market to realize that. Yellen is now in 3rd place with 19% odds. Since her Jackson Hole speech was in direct conflict with the President, because she defended regulations, it seems very unlikely that she will be picked. The latest person who was interviewed is Jerome Powell; he’s at 30%.
There’s a 79% chance the pick is either Powell or Warsh. Warsh is good on regulations, but he’s a hawk. Powell is an establishment dove, but he isn’t as great on deregulation as President Trump would like. For the most part, the markets are focused on the monetary policy effects of who the next choice will be. If it’s Warsh, expect a complete unwind of the balance sheet and higher rates. If it’s Powell, expect no change to the current policy. That means the balance sheet will be between $2.4 trillion and $2.9 trillion when this unwind is done. The Fed funds rate will be raised gradually as the market and economic data permit. We’re in a bizarre circumstance where polar opposites are being considered. This means that the next few days will have big impacts on the market. President Trump will make his selection sometime in the next 3-5 weeks.
When Warsh’s odds improve, expect a sell-off in tech stocks and a rally in the banks. The FANG stocks are negatively impacted by rising rates and the banks are positively impacted as their net interest margins improve. Powell would have the opposite effect, causing a snapback rally in tech stocks and small cap banks to fall. Warsh would also cause a selloff in bonds. You can see the recent action moving in this direction in the chart of the 2 year bond below.
