As Fed Chair Jerome Powell’s term ends next year, our Global
Chief Economist Seth Carpenter discusses the potential policy
impact of a so-called “shadow Fed chair”.
Read more insights from Morgan Stanley.
----- Transcript -----
Welcome to Thoughts on the Market. I’m Seth Carpenter,
Morgan Stanley’s Global Chief Economist. And today – well,
there’s a topic that’s stirring up a lot of speculation on Wall
Street and in Washington. It’s this idea of a Shadow Fed
Chair.
It’s Monday, July 21, at 2 PM in New York.
Let’s start with the basics. Fed Chair Jerome Powell’s term
expires in May of next year. And look at any newspaper that
covers the economy or markets, and you will see that President
Trump has been critical of monetary policy under Chair Powell.
Those facts have led to a flurry of questions: Who might succeed
Chair Powell? When will we know? And—maybe most importantly—how
should investors think about these implications?
President Trump has been clear in his messaging: he wants the Fed
to cut rates more aggressively. But even though it seems clear
that there will be a new Chair in June of next year, market
pricing suggests a policy rate just above 3 percent by the end of
next year. That level is lower than the current Fed rate of 4.25
[percent] to 4.50 [percent], but not aggressively so. In fact,
Morgan Stanley’s base case is that the policy rate is going to be
even a bit lower than market pricing suggests.
So why this disconnect?
First, although there are several names that have been floated by
media sources, and the Secretary of the Treasury has said that a
process to select the next Chair has begun, we really just don’t
know who Powell’s successor would be. News reports suggest we
will get a name by late summer though.
Another key point, from my perspective, is even when Powell’s
term as Chair ends, the Fed’s reaction function—which is to say
how the Fed reacts to incoming economic data—well, it’s probably
not going to change overnight. The Federal Open Market Committee,
or the FOMC, makes policy and that policy making is a group
effort. And that group dynamic tends to restrain sudden
shifts in policy. So, even after Powell steps down, this internal
dynamic could keep policy on a fairly steady course for a
while.
But some changes are surely coming.
First, there’s a vacancy on the Fed Board in January. And that
seat could easily go to Powell’s successor—before the Chair
position officially changes. In other words, we might see
what people are calling a Shadow Chair, sitting on the FOMC,
influencing policy from the inside.
Would that matter to markets?
Possibly. Especially if the successor is particularly vocal and
signals a markedly different stance in policy. But again,
the same committee dynamics that should keep policy steady so far
might limit any other immediate shifts. Even with an insider
talking. As importantly, history suggests that political
appointees often shed their past affiliations once they take
office, focusing instead on the Fed’s dual mandate: maximum
sustainable employment and stable prices.
But there are always quirky twists to most stories: Powell’s seat
on the Board doesn’t actually expire when his term as Chair ends.
Technically, he could stay on as a regular Board member—just like
Michael Barr did after stepping down as the Vice Chair for
Supervision. Now Powell hasn’t commented on all this, so for now,
it’s just a thought experiment.
But here’s another thought experiment: the FOMC is technically a
separate agency from the Board of Governors. Now, by tradition,
the chair of the board is picked by the FOMC to be chair of the
FOMC, but that's not required by law. In one version of the
world, in theory, the committee could choose someone else.
Would that happen? Well, I think that's unlikely. In my
experience, the Fed is an institution that has valued orthodoxy
and continuity. But it’s just a reminder that rules aren’t always
quite as rigid as they seem. And regardless, the Chair of the Fed
always matters. While the FOMC votes on policy, the Chair sets
the tone, frames the debate, and often guides where consensus
ends up. And over time, as new appointees join the Board, the new
Chair’s influence will only grow. Even the selection of Reserve
Bank Presidents is subject to a Board veto, and that would give
the Chair indirect sway over the entire FOMC.
Where does all of this leave us?
For now, this Shadow Chair debate is more of a nuance than the
primary narrative. We don’t expect the Fed’s reaction function to
change between now and May. But beyond that, the range of
outcomes starts to widen more and more and more.
Until then, I would say the bigger risk to our Fed forecast
isn’t politics. It's our forecast for the economy—and on that
front we remain, as always, very humble.
Well, thanks for listening. And if you enjoy the show, please
leave us a review wherever you listen; and share Thoughts on the
Market with a friend or colleague today.
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