The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.
President Donald Trump is considering three leading candidates for Federal Reserve chair, and is expected to make an announcement by Nov. 3. Does it make a difference for investors which one Trump chooses to lead the Fed, the nation’s central bank?
Yes, says Kathy Jones, chief fixed income strategist for the Schwab Center for Financial Research.
“In my view, it’s a big deal for two reasons,” Kathy says. “The first is that the chairman of the Federal Reserve has a lot of influence on what the staff researches, which factors are most important in considering policy changes, and in building consensus. Whenever someone new steps into the role, it makes a difference.”
The second reason the Fed chair matters is that there are other positions open at the Fed that the administration will have the opportunity to fill, including vice chairman and two other governors on the board, Kathy says. Depending on who is appointed, a broad change in philosophy at the Fed is possible, which could have an impact on the markets.
“The biggest risk, in my view, is that we’ve grown accustomed to thinking the Fed will ease policy any time the markets go into a downturn,” Kathy says. “If that view changes, then it could mean a lot more volatility in markets going forward than we’ve seen in nearly two decades.”
Here is a brief look at the three top candidates:
Taylor, a Stanford University economist, represents the biggest potential change for the Fed, Kathy says.
“He has been an advocate of a ‘rules-based’ approach in setting policy and has been outspokenly critical of the Fed’s use of quantitative easing,” Kathy says. “Even though he might temper his views if appointed, the most likely outcome would be tighter monetary policy and a possibly an entirely different approach. He seems to be the favorite of the more conservative branch of the Republican Party, many of whom are Trump supporters.”
Powell, a member of the Fed’s Board of Governors, is more of a centrist, Kathy says.
“He was initially skeptical about quantitative easing, but has never cast a dissenting vote,” Kathy says. “He would likely represent continuity at the Fed, with perhaps a slightly hawkish tilt. He doesn’t seem to have a ‘philosophy’ about policy, so one would assume a continuation of the current approach for now.”
Yellen, the current Fed chair—whose four-year term ends in February, but who could be renominated to a second term—represents consistency and is assumed to have a "dovish tilt," meaning she has been thought to favor low interest rates, Kathy says.
“However, she is leading the Fed down the path of unwinding the balance sheet and hiking rates, so if reappointed, she could surprise the market with being more hawkish than anticipated,” Kathy says.
All this is happening at a time when the Fed is trying to reduce its balance sheet and normalize interest rates. “The bottom line is that all three would likely preside over a tightening cycle that has already begun,” Kathy says. “It’s more a question of how fast and how much rates will rise, than if policy will tighten.”
What investors should consider now
Kathy recommends likes keeping the duration of your fixed income portfolio in the three-to-seven-year range and focusing on bonds with relatively high credit ratings.
By shortening duration, you can reduce the interest rate risk associated with the possibility that the Fed hikes more than anticipated. It also reduces the risk associated with inflation picking up more than expected.
Meanwhile, focusing on higher-credit-quality bonds can reduce overall credit risk, which could help your portfolio better weather a market downturn if conditions should change unexpectedly.