On Thursday, Rogoff (Harvard economist) was out saying he thought “a reasonable compromise” for a Fed Chair pick would be John Taylor. I nearly spit out my tea. The Taylor Rule currently implies a FF rate that is 3.65% (over 300 bps higher). That could cause a massive break in curvature – pricing in rapid hikes followed by eases, which would invert the curve, assuming the economy doesn’t implode first. How is picking a backward-looking data-fitter and one of the most hawkish people on the planet a “reasonable compromise”?!? [Note to self: ignore Rogoff in the future] If we don’t get spectacular growth to justify a massive increase in rates, this will surely cause a recession. This bit of “news” made me think more about the next Fed Chair.
I then got a flashback to Hensarling and his army of Congressmen who want the Fed to follow a rule. It’s not clear to me how much sway this contingent will have. My impression is that Trump would like someone who is more of a “yes” man – someone less likely to want to be independent and defend the independence of the Fed. An independent Fed could go against Trump’s policies and start putting the brakes on excess growth. There is no point in having a “yes” man if they have to follow a policy rule. To summarize:
- policy rule = brakes on economy,
- independent Fed = less brakes on economy, and
- “yes” man = whatever Trump wants.
You decide what’s going to make the most sense to the Donald.
It seems to me that we could get a signal from his first 100 days. All other things being equal, if Trump is not in a rush to change the current make-up and direction of the FOMC, he may take a little longer to choose the two empty Fed Governor vacancies. We can see from his selections what direction he seems to be leaning toward. Yellen was officially nominated on October 9, 2013 (for a Feb 1, 2014 start), so we may not get an official nomination for the (new) Fed Chair until the second half of next year.
I have no competitive advantage in guessing who the next Chair will be, so I have been in a “wait and see” mode. Considering Trump’s already broken a number of campaign promises, not renewing a then-71 year old Yellen who can be an easy scapegoat for savers’ woes seems like a no-brainer. But there are plenty of reasonable choices for Fed Chair out there.
I mentioned in past issues that common sense dictates that guy with a real estate background, a guy who has had problems making debt payments in the past, and a guy with a stated goal of 4% GDP growth can’t possibly want a hawkish Fed Chair. At the end of the day, he is a businessman. He wants companies to invest in the US and he need to borrow to fund his stimulus plan. How is he going to want higher rates?!? Am I in Bizarro World? But we should look at some cheap tail protection trades (cheap/free OTM bear flatteners), just in case. And we should stay away from trades that get short the 2018 meetings from the current levels (<2 hikes in 2018).
 This, combined with that large U7 3mo double fly trade by an “800lb” gorilla (see the Appendix and the next section) which I think could be related to the Fed Chair appointment.
 The current Fed seems more likely to consider global downside risks, and more willing to let the economy run hot.