Markets respond to Fed chair nomination
We explore how markets have reacted to President Trump nominating Kevin Warsh as new Federal Reserve chair.
Warsh nominated as Federal Reserve chair
A few weeks ago, we discussed Kevin Hassett, who President Donald Trump was strongly hinting would be his nominee for Fed chair. That’s now history. Instead, the president has nominated former Fed Governor Kevin Warsh. The question is – does this have implications for investments?
We know that President Trump is anxious to replace Jerome Powell as Fed chair because he wants interest rates to be lower. That aligns with the recent commentary Kevin Warsh has been providing, in which he too suggests that interest rates are too high and are disadvantaging small businesses. This sounds as if it aligns with President Trump’s ‘man of the people’ instincts, but Warsh’s views still seem to clash with those of the president, and to a surprising extent.
Warsh says “[the Fed] should abandon the dogma that inflation is caused when the economy grows too much and workers get paid too much. Inflation is caused when government spends too much and prints too much.”
President Trump has been explicit about wanting lower interest rates to support the housing market, but also to lower the federal interest expense. This is a concept called fiscal dominance, which means setting interest rate policy to ease fiscal challenges rather than moderate inflation, and it seems like one Kevin Warsh would struggle to find peace with.
Warsh emphasises the role of credibility, which he says Powell has undermined through the use of the Fed balance sheet during lockdown. He accuses the Fed of prioritising Wall Street over Main Street (the financial sector over more traditional businesses). As such, he’s been advocating reducing the balance sheet (selling the bonds the Fed holds to justify cutting interest rates, which he says would support Main Street over Wall Street).
Warsh has also stated that he believes the dollar’s role as a reserve currency brings benefits to the U.S. There was quite a market reaction to this because it seems so at odds with the rhetoric and actions that have come from the Trump administration. The idea of shrinking the Fed balance sheet would seem set to put upward pressure on bond yields and mortgage rates, and make longer-term borrowing more expensive.
Some within the Trump administration have wanted a weaker dollar to support the manufacturing industry – Kevin Warsh doesn’t seem to advocate that.
So, despite the preference for lower interest rates, Kevin Warsh seems like quite an austere choice for a president who wants to use interest rates to reduce the federal interest expense.
Understandably, the rumour caused quite sharp reversals in the gold and silver markets, which had been performing extremely well. Gold rose from below $4,000 per troy ounce as recently as November, briefly touching $5,600 on an intraday basis before dipping back towards $5,000.
Source: Bloomberg
Treasury yields rose as the news was digested and the dollar, which had been in freefall, began to rise.
These moves seem quite rational. Appointing a generally hawkish advocate of a strong dollar as Fed chairman weakens the evidence that the dollar is going to be debased over time, and that monetary policy will be used to suppress interest rates to help fund the deficit. What it doesn’t do, however, is reduce the size of the budget deficit and therefore the amount of bonds the federal government will need to issue. Nor does it create an alternative mechanism for dealing with that debt burden. And it seems unlikely that it reflects a change in President Trump’s desire to see interest rates lower in order to reduce the federal interest rate bill.
LSEG: Datastream
Earnings season is underway
Away from Washington, earnings season proceeds with the first batch of technology company earnings. As always, the beats-to-misses ratio appears normal (80% for equities, around 60% for sales) and the general message from companies has been that consumers remain in decent shape.
Any market disappointment has tended to be on the basis of guidance rather than results. U.S. equities were on track for modest gains over the week, most of which were lost for overseas investors due to the dollar depreciation that preceded Kevin Warsh’s appointment.
