John Taylor, Kevin Warsh, Gary Cohn, Jerome Powell or Janet Yellen. As of February 2018, 1 of those 5 individuals will be given the captaincy of the Fed squad. If it becomes 1 of the 4 first named, the bank gets a new captain. If the choice falls on Yellen, the current captain will continue to fulfill that role.
It almost never happens that the outside world only learns in January who will lead the Fed. In order not to create additional uncertainty on the financial markets, the American president usually decides in October or November who he will nominate. The Senate, the American Senate, must then approve the appointment.
Donald Trump has narrowed his search to the 5 people mentioned and white smoke will be coming out of the White House sometime in the coming weeks. What could his decision mean for the financial markets?
The choice for Yellen
Let's start with the easiest, namely the scenario in which he leaves everything as usual and reappoints Janet Yellen as Fed chair. In that case, investors would have to deal with the status quo. Since Yellen's monetary preferences are well known, there would be no reason to reconsider the Fed's future policy. So if Trump wants to keep the financial markets calm, he will choose Yellen.
There are plenty of reasons why that can happen. For starters, because she's on the shortlist. She is also a strong supporter of an accommodative monetary policy. That would suit Trump, because he has promised large-scale tax cuts and investments in infrastructure. Both could lead to a higher budget deficit and national debt, at least in the short term. A low interest rate is then preferable to a high interest rate.
However, during the election campaign, Trump did not speak highly of Yellen. He called her policies scandalous. Another thing working against Yellen is that she is an Obama president. In short: she was appointed by President Obama. Trump is known for wanting to erase every memory of his predecessor. With a view to the future, it is obvious that Trump will choose his own chairman, someone he can probably influence to follow a certain policy.
The smallest opportunities
Of the other 4 candidates, I estimate that Gary Cohn has the smallest chance. Until recently he had a good relationship with Trump, a clear advantage, but relations have cooled off recently.
Jerome Powell is already a member of the Fed board. I haven't found anything that would make me say Trump is leaning in his direction. I wouldn't be surprised if it ends up being between Warsh and Taylor, along with Yellen.
Kevin Warsh then?
Kevin Warsh has Fed experience. He was already a member of the Fed board between 2006 and 2011. During his Fed stint, he showed himself to be a monetary hawk. In short: a central banker who is not a big fan of a very loose monetary policy. He has often criticized the policies under both Yellen and her predecessor Ben Bernanke.
However clear he has been in his criticism, he is vague about what kind of policy the Fed should pursue. His appointment could lead to a lot of uncertainty on the financial markets. On the one hand because he has the image of a hawk, but on the other hand also because what he really stands for remains fairly vague. If the choice is Powell or Cohn, the additional uncertainty would probably be smaller than if Trump chooses Warsh.
What are John Taylor's chances?
Finally, John Taylor. Taylor is well known in monetary and academic circles as the inventor of the so-called Taylor rule. This concerns how high the interest rate, which the central bank sets, should be. He has developed a formula for this. Under that rule, the Fed rate should currently be between 3% and 4% instead of 1,25%, which is where the Fed rate is found.
That seems to reduce his chances but, coincidentally or not, Taylor announced after his conversations with Trump that that rule is quite flexible and can also be interpreted as meaning that the interest rate must now be much lower than 3% to 4%. This could be a sign for Trump that Taylor can be influenced, something President Trump would welcome.
Should Trump choose Taylor or Warsh, it is expected that the first reaction may be that the dollar strengthens and US interest rates come under further upward pressure because both are known as monetary hawks.
A lot of influence
It is true that the chairman of the Fed has more influence than the other board members, but it is also true that this does not mean that he/she can do anything. He or she has to deal with economic reality, which is such that a rapid series of interest rate increases could lead to a new recession in the US. Even if Warsh or Taylor takes over, that reality will quell their hawkish tendencies.
If the President chooses Cohn or Powell, it is obvious that the market reaction will be much less pronounced. At most, a few wrinkles can be expected with a possible reappointment of Yellen. In the longer term, the appointment of Warsh or Taylor would mean that, as soon as possible, the Fed will normalize official interest rates more quickly and, in the event of a next recession or danger of one, would be less likely to opt for large-scale purchases of government bonds than under Yellen, Powell or Cohn.