Federal Reserve Chairman Jerome Powell poses for photos with Fed Governor Lael Brainard (L) at the Federal Reserve Bank of Chicago, in Chicago, Illinois, U.S., June 4, 2019.
Ann Saphir | Reuters
If Lael Brainard is named Federal Reserve chair, the first move by financial markets may be to price in an even more dovish central bank.
That means the Fed would be expected to take longer to raise interest rates or tighten policy than under Fed Chair Jerome Powell. Currently, traders are expecting the central bank to begin raising rates in the second half of next year, once it winds down its bond-buying program.
Until just recently, Powell was expected to be renominated to the chairmanship, but President Joe Biden has now interviewed both Powell and Brainard and is expected to make an announcement by the weekend.
“I think the market views Brainard as slightly more dovish. I think the honest answer is there probably is not a significant difference between either candidate. The biggest asset that Powell has is the trust and the confidence of the market, and a kind of a track record of doing exactly what he thinks is right despite the considerable amount of political pressure,” said Ed Mills, Washington policy strategist at Raymond James.
Economists and investors perceive Brainard as more political, whether she proves to be or not. Mills said she is seen as political because of her donation to the presidential campaign of Hilary Clinton in 2016.
“Powell, I think, will be much less concerned about the midterm elections in determining when they should raise interest rates,” said Peter Boockvar, chief investment officer at Bleakley Global Advisors. “I’m not saying that’s what Brainard is going to do if she’s in that seat, but that’s going to be the perception.”
The choice of either candidate is not expected to be tumultuous for stocks, but financial markets could react.
Market impact to Brainard nomination
Boockvar and others do not expect much market reaction at all to Powell, if he is nominated for four more years, but it could be different in the case of Brainard.
“I think you’ll get a 10-minute bounce in the [stock] market if Brainard gets the appointment, and you’ll see more than just a 10-minute response in the Treasury market, where you’ll see a steepening yield curve,” Boockvar said.
Bond strategists say if Brainard is nominated, market inflation expectations could rise, with inflation-related instruments moving higher, like Treasury-inflation protected securities. The spread between the yields of shorter duration Treasury notes like the 2-year and longer duration notes like the 10-year could widen, with the 10-year yield rising due to inflation concerns.
Brainard, 59, has been a Federal Reserve Board governor since 2014. She was a former Under Secretary of the Treasury for International Affairs, during the Obama administration.
The 68-year-old Powell has been Fed Chairman since 2018. A Republican and former private equity executive, he was appointed to the Federal Reserve Board by President Barack Obama in 2012 and named chairman by President Donald Trump.
“The reason why I keep going back to Powell, putting my political hat on, Biden would own any negative consequence that results from monetary policy, even more so if he changes who is at the top of the Fed,” said Mills.
Tougher on banks?
Brainard had been backed for the chairmanship by progressives in the Democratic party who want to see tougher banking regulation.
“I still think Powell makes sense, if only in that he is the easiest from a confirmaton perspective. He would also provide cover for the progressive nominees that will fill the other slots,” said Isaac Boltansky, director of policy research at BTIG.
Biden could appoint three other Federal Reserve board members, and as many as four if Powell were not renominated and he chose to resign. The term of Fed Vice Chairman Richard Clarida will end in early 2022. Fed Vice Chairman for Supervision Randal Quarles recently resigned, effective at the end of December. There has also been a vacant seat on the board.
Brainard is expected to also be under consideration for either the position now held by Clarida or the one exited by Quarles.
“Two weeks ago, I thought Chairman Powell was a shoo-in to be reappointed. Now, I’m not sure. The odds and probabilities seem to be falling. The higher-than-expected inflation readings hurt, the trading scandals hurt, and the fact he’s a Trump appointee makes him an easy scapegoat for the administration,” said Michael Arone, chief investment strategist at State Street Global Advisors U.S. SPDR business. “Putting those things together and the fact it’s taking so long, points to me the odds of his reappointment are declining.”
Diane Swonk, chief economist at Grant Thornton, said the market may get it wrong if it paints Brainard as more dovish.
“The biggest difference between her and Powell is she might be faster on climate change, though Powell was pretty quick on the uptake. The other issue is she’s much more open to cryptocurrency for the Fed, and that’s the biggest difference I know between them,” she said. “He’s reluctant to get too far ahead of other central banks. She’s been really involved in fintech and the digital space for awhile.”
Swonk said she views Powell and Brainard as equally competent but her preference is for continuity given the challenges the Fed and economy are facing.
“This is going to be a very difficult navigation, and the Fed’s going to need all hands on deck,” Swonk said. “Any certainty at this stage of the game is good, and that’s why continuity helps. The fact people perceive her as [more dovish] may be wrong, but it may be significant.”
Michael Schumacher, Wells Fargo director rates, said it’s unclear if the market is already pricing in some expectation for Brainard’s nomination. Treasury market 5-year breakevens were lower Wednesday, but they are up 6 basis points from a week ago. At 3.16%, they indicate traders expect an average level of inflation of 3.16% over the next five years. That was at 2.87% on Nov. 2, the day before the Fed’s last meeting statement and press briefing.
“She could be tougher on banking regulation and climate change, and the wealth gap. That’s where she’ll look to put her fingerprints on the chairman’s role,” said Arone. “Those are the areas where they differ, and also why so many progressive Democrats are pushing for her appointment. Powell’s downfall would be that he misinterpreted inflation. But her policies, should she get in, are unlikely to cool inflation.”
Sam Stovall, chief investment strategist at CFRA, said the Dow Jones Industrial Average has had an annual compounded growth rate of 11% under Powell.
“That puts him in the middle of the 16 Fed chairs since 1914,” he said. The median compounded annual growth rate under all Fed chairs was 8.5%. The best was Daniel Crissinger in 1923 to 1927, with a pace of 17.5%, followed by Paul Volcker’s 15.4% from 1979 to 1987.
“If Powell is renominated, we probably end up seeing both stocks and bonds move higher,” said Stovall. Brainard would bring an element of uncertainty, and that could initially be negative but her perceived dovishness may be a plus for stocks. Stovall notes the Dow has posted a near 4% median gain in the first six months of a new Fed chair and has risen two-thirds of the time.
“Bonds yields could move a little higher. We already know what the trajectory of tapering is likely to be and when the first rate increase is likely,” said Stovall. “If Brainard is nominated, the equity market either goes up a little more than they would with a Powell renomination or they tread water.”
Morgan Stanley Investment Management’s Jim Caron said the two would be very similar when it comes to policy and the market may only move marginally if Brainard is nominated. “It’s not like either one would be dramatically different from the other,” Caron said. “It’s not like you’re going from a hawk to a dove. You’re changing leadership, not changing philosophy.”