WHY POWELL COULD BE OUT OF THE FED, AND WHAT IT MEANS FOR MARKETS / BARRON´S MAGAZINE

Why Powell Could Be Out at the Fed, and What It Means for Markets

By Lisa Beilfuss

Fed Chairman Jerome Powell, shown at a Senate panel hearing on the Cares Act on Tuesday, would almost certainly win renomination, but his chances took a small hit this past week. / Kevin Dietsch/Getty Images

It was easy to miss one development in Washington, D.C., that has more potential consequence for investors than partisan brinkmanship over a debt ceiling that must get lifted and intraparty fighting over just how many trillions will be spent over the next decade.

When Federal Reserve Chairman Jerome Powell testified before the Senate Banking Committee on Tuesday, he defended the Fed’s response to the Covid pandemic, updated Senators on the status of emergency facilities, and fielded questions about the state of the economy. 

He also took a lambasting from Sen. Elizabeth Warren (D., Mass.) that, while not altogether surprising, was jarring in light of the looming expiration of his four-year term.

“Your record gives me grave concern,” Warren said to Powell. 

“You have acted to make our banking system less safe, and that makes you a dangerous man to head up the Fed.” With that, Warren said she will oppose a Powell renomination.

On its face, Warren’s opposition seems safe to dismiss. 

After all, many politicians use televised hearings to grandstand and zing. 

Warren’s displeasure with Powell over his support for policies that have eased bank regulation isn’t new, and economists and Washington insiders alike say that Powell has strong bipartisan support. 

But the question isn’t whether Powell would be confirmed; he would be.

The bigger issue is how badly Warren wants Powell gone, how loud she is behind the scenes, and how closely President Joe Biden is listening. 

In context of the multilayer mess in Washington that has progressive Democrats pitted against moderates and battling for control of the party, investors should begin to ponder the possibility that Powell won’t be renominated.

As Ed Yardeni, president of Yardeni Research, puts it, “Is Powell ‘transitory?’ ” 

Powell has often said that this year’s surge in inflation is likely to be “transitory,” and the word may soon apply to Powell’s tenure at the Fed, Yardeni says. 

“I suspect that our progressive president may prefer to replace Powell, who has pivoted to the left over the past couple of years, with someone more consistently progressive like Fed governor Lael Brainard.”

A month ago, Wall Street was all but certain that Powell would helm the central bank for another four years. 

Now it is less certain, says Krishna Guha, vice chairman at Evercore ISI. 

Confidence in the likelihood of reappointment started to ebb after Biden didn’t announce an early renomination around Labor Day, as was the case with former President Barack Obama and then-Fed chief Ben Bernanke in the aftermath of the financial crisis. 

Confidence waned further after the recent trading controversies involving two Fed presidents came to light.

Then, says Guha, “Senator Warren went for the jugular.” 

A prominent senator is attempting “to kill off a putative nominee,” and the tenor of her opposition highlights the political cost to Biden within his party of proceeding with reappointment, Guha says. 

While he still thinks odds favor Powell, it has become clear that it isn’t a done deal.

Betting markets are reflecting that shifting sentiment. 

Powell’s odds of renomination hovered around 80% to 90% in recent months, according to PredictIt, and the site still shows him as the clear favorite. 

But odds dropped precipitously after Tuesday’s hearing, to about 60%, as bets rose that Brainard would be nominated.

The decline in odds, which have recovered some, may still be underestimating the threat to Powell’s extended tenure. 

First, consider the power that progressives are wielding. 

That’s clear as Biden’s two-tracked budget remains stuck, with House progressives refusing to vote for the bipartisan $1.2 trillion infrastructure bill that has passed the Senate until they see the bigger social-policy and climate package that moderates want to shrink. 

The larger bill itself, for which Democrats are using the reconciliation process because it requires only a simple majority in the Senate, highlights Biden’s left turn.

Second, Warren in particular appears to have had significant influence already on the current administration’s nominees. 

Two prominent regulatory spots have gone to the candidates she backed—with Lina Khan as head of the Federal Trade Commission and Rohit Chopra as head of the Consumer Financial Protection Bureau. 

Fed presidents Kaplan and Rosengren resigned shortly after Warren’s call, in response to reports of their trading activity, to ban ownership and trading of individual stocks by senior Fed officials. 

And Warren has focused much of her attention on Fed governor Randal Quarles, vice chairman for supervision, who isn’t expected to be renominated when his term ends on Oct. 13.

So what is the upshot for investors if Biden passes on Powell? 

In the near term, strategists say, expect some turbulence, as markets would lose a popular Fed chief who has been aggressive in his pandemic response and careful in communicating monetary policy. 

A Fed led by Brainard would be even more dovish, meaning that investors would have to balance the benefit of low interest rates for even longer with the rising risk that the Fed is already behind the inflation curve.

“A replacement would be even less likely to normalize policy,” says Joe LaVorgna, chief economist at Natixis. 

“That’s a longer-term problem.” 

Also, he says, a change at the top would signal that the administration wants the Fed to go in a different direction, probably getting tougher on Wall Street as well as veering from its double mandate of full employment and price stability to consider things like climate change.

Whether or not Powell is renominated, investors should brace for a shake-up at the Fed, given the coming expiration of Vice Chair Richard Clarida’s term in addition to the expiration of Quarles’. 

Kathy Bostjancic, economist at Oxford Economics, says that Biden may package the three nominations—meaning an announcement could come in the next two weeks, just as the debt ceiling deadline hits.

Through the turmoil in Washington, markets have enjoyed a lack of surprise and drama from the Fed. 

But politics may soon ensnare it, making Warren’s warning shot worth heeding.