How did markets react to Kevin Warsh's appointment? It's hard to say. Donald Trump's announcement in late January did not trigger much movement, either in equities or in yields. And the rest of the news cycle quickly took back control of the market narrative, with the earnings season in full swing.
In recent months, investors had reason to fear the appointment of someone close to Donald Trump and openly in favor of lower rates to succeed Jerome Powell. But out of the four finalists - Kevin Warsh, Kevin Hassett, Rick Rieder and Christopher Waller - Donald Trump ultimately chose the candidate with the most hawkish reputation.
During his time at the Fed as a governor (2006-2011), Kevin Warsh defended positions that placed him in that category. He resigned because he opposed the second round of quantitative easing implemented by the Fed.
The day after the announcement, The Wall Street Journal called it "the best appointment of President Trump's second term.” In that editorial, the Journal highlighted an interesting point: a central banker seen as hawkish can more easily keep rates low (if credible on inflation, inflation expectations stay anchored and rates do not rise) than a dove or a loyalist of the president.
Still, it is difficult to know whether Warsh can still be considered a hawk, since in recent months he has lined up behind Donald Trump's calls for the Fed to cut rates further. While that stance was obviously a prerequisite for landing the job, Warsh also has a view of the US economy that provides a rationale for aligning with the president. He believes AI will drive a productivity boom and, therefore, disinflationary growth. That is what the United States experienced in the 1990s.
Caught between a hawkish reputation and dovish positions, the market likely does not quite know what to make of this appointment. Hence the limited reaction to his selection.
But in the coming weeks, the bond market could become more animated. That, at least, is what history suggests. All seven of Kevin Warsh's predecessors saw yields rise in the three months following their appointment. The market tends to come and test the credibility of a new Fed chair.
Changes in short-term (2-year) and long-term (10-year) yields three months after the appointment of a new Fed chair.
For Kevin Warsh, that testing period may be longer, because he must first be confirmed by the Senate. The process has been blocked by Republican Tom Tillis, who opposes the Justice Department probe into Jerome Powell over cost overruns tied to the renovation of the Fed's headquarters and possible perjury during his testimony to Congress last June.
What is certain is that markets remain an important disciplining force. If a Fed chair wants to cut short-term rates aggressively, he will be punished by a rise in long-term rates (because inflation expectations rise if the Fed appears to abandon its inflation target).
