(Bloomberg) -- Wall Street investors and strategists said that President Donald Trump's pick of Kevin Warsh to lead the Federal Reserve is a relatively hawkish choice, likely to resist balance-sheet expansion which will support the dollar and a steeper Treasury yield curve.
If confirmed by the Senate, Warsh — despite his track record of often supporting higher interest rates because of fears of inflation — will need to navigate a president who in his second term has pilloried Fed officials for not easing policy as aggressively as he would like. The dollar gained and the Treasury curve steepened.
Across Wall Street and among global investors, Trump's pressure campaign to lower borrowing costs has sparked concerns about the independence of the central bank in setting benchmark interest rates that shape the cost of borrowing in markets around the world.
"Markets are responding in kind on the belief that of the Fed Chair candidates, we're about to get the more hawkish one," said Peter Boockvar, chief investment officer at Onepoint BFG.
Bloomberg's dollar gauge rallied Friday morning in New York after Trump announced the post on social media. Short-term Treasury yields fell while those on longer tenors rose. US stock futures slipped alongside precious metals prices.
Warsh, who served on the Fed's Board of Governors from 2006 to 2011, would succeed Jerome Powell. Wall Street market-watchers also noted that the incoming Fed chair will need to forge a consensus on rate policy across the Federal Open Market Committee's 12 voting members. Powell, who Trump appointed as chair in 2017, will step down as chair on May 15, though his term as a governor of the Federal Reserve board will run until 2028.
Here's what investors and strategists across Wall Street are saying:
Gennadiy Goldberg, head of US rates strategy at TD Securities
"The market is twist steepening on the nomination of Kevin Warsh as the market remains notably worried about Fed independence. Warsh will also be difficult for markets to read over a longer horizon since he has been critical of the Fed for a long time, but much of that criticism is about the Fed being too dovish.
He's also opposed to the Fed using the balance sheet. However, the Chair is only one of 12 voting members and still needs to convince his colleagues to either cut rates or change balance sheet policy, neither of which is likely in the near-term. For now it's status quo, but markets will remain on edge until Warsh makes his views clearer."
Zach Griffiths, head of investment-grade and macro strategy at CreditSights
"The twist steeper in the curve makes sense. Perhaps Warsh can get on board with emphasizing productivity gains from AI as an argument for lower rates, but he's been very critical of the Fed's balance sheet expansion, so perhaps less optimism in terms of the Fed using its balance sheet to manage borrowing costs at the longer end of the curve in the future."
Priya Misra, portfolio manager at JPMorgan Investment Management
"The market reaction of tighter financial conditions and a steeper Treasury curve focuses on Warsh's criticism of a larger balance sheet. However, the balance sheet decision is also dependent on the equilibrium level of reserves, and we think other Fed members will not be supportive of any shrinkage of the balance sheet."
Erica Camilleri, a senior global macro analyst at Manulife Investment Management
"Warsh's nomination as Fed Chair is likely to be accompanied by some element of Federal Reserve reform which should keep the US risk premia elevated, acting as a headwind to the USD and supports our EUR/USD target of 1.25."
David Robin, an interest-rate strategist at TJM Institutional Services LLC
"Warsh is a data-dependent, Fed-credibility choice, so Fed watchers can breathe a bit of a sigh of relief.
Conversely I'm hard-pressed to think Trump would appoint anyone that didn't commit to lower rates over time starting in June. But I think any definitive longer-term market reaction needs time and data."
Tony Farren, managing director in rates sales and trading at Mischler Financial Group
"I'm not surprised Treasuries would sell off, but I'm surprised at the shape of the curve, because of his reputation. I'm sure he had to concede some things but once he has the job he can do whatever he wants.
I thought the curve would flatten with a Warsh announcement just because of his hawkish reputation — less cuts but lower inflation and a stronger dollar — and we're getting the opposite. I think that will reverse.
Stocks are having the reaction I expected — weaker because they're anticipating less rate cuts with Warsh over Hassett, with a stronger dollar because he's well respected and has a firm grip on policy."
Ed Al-Hussainy, portfolio manager at Columbia Threadneedle Investments
"If Warsh is priced to be less credible on inflation, long end breakevens should be higher," and also expect higher rate volatility given "higher uncertainty around both near term Fed path and long term inflation expectations."
"What we don't know is how Warsh will act in the seat, whether the short term consensus on the FOMC will shift and become less sensitive to data, and whether other administration priorities, lower mortgage rates will impact decisions."
Ian Lyngen, head of US rates strategy at BMO Capital Markets
"It is a moderate bear steepener — and we've already seen that priced in. The logic is that investors view Warsh as less likely to use the Fed's balance sheet to influence longer dated Treasury yields. It hasn't changed our outlook for the Fed — still 50-100 basis points of cuts this year depending on how the data develops. Warsh is a good choice for Fed credibility."
Elias Haddad, global head of markets strategy at Brown Brothers Harriman
"If Warsh's Fed policy vision is implemented, the US yield curve could steepen further as short rates fall, while longer-term rates may stay sticky or even drift higher due to lack of US fiscal credibility."
Krishna Guha, head of central bank strategy at Evercore ISI
"The Warsh pick should help stabilize the dollar somewhat and reduce (though not eliminate) the asymmetric risk of deep extended dollar weakness by challenging debasement trades – which is also why gold and silver are sharply lower.
But, we advise against overdoing the Warsh hawkish trade across asset markets – and even see some risk of a whipsaw. We see Warsh as a pragmatist not an ideological hawk in the tradition of the independent conservative central banker."
Alex Cohen, foreign-exchange strategist at Bank of America
"In the short term, the market is well aware that any of the candidates would be advocating for lower rates, so the immediate implications should be limited. Warsh is a well known hawk when it comes to the Fed's balance sheet. Will that continue to be true if presumed rate cuts don't translate out the curve will be the critical thing to watch."
--With assistance from Laura Avetisyan, Alice Atkins, Ye Xie, Ruth Carson, Alice Gledhill, Miles J. Herszenhorn, Elizabeth Stanton, Anya Andrianova and Michael MacKenzie.
More stories like this are available on bloomberg.com
