(Bloomberg) -- The biggest uncertainty for investors watching the Federal Reserve in coming months may not be the rate of inflation but turnover at the top of the U.S. central bank.
Chair Jerome Powell and vice chairs Richard Clarida and Randal Quarles could all potentially be replaced in the coming year, depending on how much President Joe Biden wants to reshape its leadership. And while Fed chairs always matter, the choice right now is even more critical.
Fed officials are deliberating under a new policy framework adopted last year with Powell’s stewardship. It grants great discretion over when to reduce support for the U.S. economy as it recovers from Covid-19.
Biden’s choice will come to the fore in coming months and there’s no indication that a decision is imminent. Meanwhile, the central bank is focused on testing the outer limits of full employment, calling it a broad and inclusive goal, while permitting inflation to overshoot its 2% target.
It’s laid out some guidance about how it will know when to starting scaling back massive bond purchases and lift interest rates from zero. But the new framework still leaves the Fed chair a lot of room to shape the consensus among officials and steer policy.
“If you are in a discretionary regime, it really matters who the next person is,” says Michael Bordo, a Rutgers University economist and fellow at Stanford University’s Hoover Institution. “You could get someone to stick to the script Powell is following, or somebody who can change it.”
Asked during a Politico event on Tuesday if the president should offer Powell another term, White House economic aide Jared Bernstein deflected the question, saying that it’s “neither yes nor no at this point” and added that the administration has to go through a process “before we even start talking about it.”
There’s also a vacancy on the seven-seat Board of Governors, giving Biden another opportunity to put his stamp on policy. He’s being lobbied to use that slot to improve diversity at the Fed.
The president, who says he’s not spoken to Powell out of respect for Fed independence, is likely to consult the advice of Treasury Secretary Janet Yellen, who preceded Powell in the job.
The decision -- and uncertainty around it -- comes at a time when markets are already jittery over inflation fears and questions about how long the Fed will keep interest rates near zero to bring back into the labor market those hardest hit by the pandemic.
Powell’s term as chair expires in February 2022. Clarida’s term as a Fed governor expires the month before and Quarles’ tenure as vice chair for supervision ends in October this year.
Fed watchers say Lael Brainard, the only Democrat currently on the Board, could fill any of those positions, and she has distinguished herself by dissenting against many of the majority votes on bank regulation by Powell and Quarles.
Past transitions at the helm of the central bank have produced little more than a shrug in financial markets as the consensus was that central banks should remain independent and just focus on keeping prices low and stable.
The next chair of the Fed was often the previous chair, regardless of which party controlled the White House: Paul Volcker was nominated by a Democrat and reappointed by a Republican. Alan Greenspan and Ben Bernanke were both chosen by Republicans but re-nominated by Democrats.
Donald Trump ended that four-decade tradition of continuity. The former president passed over Yellen for another term and elevated Powell, a Republican put on the Fed by President Barack Obama. In doing so, Trump showed that ignoring the model of a multi-term chair could in fact produce good results.
The experience may bolster the argument for people who want Biden to use the appointment to improve diversity at the top of the Fed. Of the six people currently on the Board in Washington, all are White and only two are women.
But the case for continuity may also weigh on Biden, who’s pursuing an ambitious economic agenda and could be wary of alarming investors who view Powell as a safe pair of hands.
“The administration is approaching a fork in the road,” said Andrew Levin, a Dartmouth College professor. “Reappointing Chair Powell to a second term would facilitate continuity at the Fed. In contrast, the White House could appoint a new chair if the aim is to foster a more significant shift in the Fed’s priorities, especially on banking regulation and payments.”
Mounting Demands
Meanwhile, expectations of what the Fed should do are changing. The Fed’s sprawling emergency pandemic aid massively expanded its footprint in credit markets, stirring interest among progressive politicians about what the Fed could do to support goals of making the U.S. economy more equitable.
California Democrat Maxine Waters (NYSE:WAT), Chair of the House Financial Services Committee, has introduced legislation that would make the elimination of racial disparities a Fed policy goal.
Powell has leaned into the national equality debate and talked about the tent city near the Fed’s Washington headquarters and the benefits of a hot economy for lower-income workers. He praised both parties for approving fiscal packages bridging the unemployed and businesses through the downturn. While some of this may be smart reading of the political climate, Powell has also voiced an unusual level of empathy for a senior central banker.
All of this has gained him the confidence of powerful Democrats pivotal for confirming Biden’s Fed nominations.
‘I Like Jay Powell’
“I like Jay Powell. I think he’s been supportive,” Sherrod Brown, an Ohio Democrat who chairs the Senate Banking Committee, said in an April 15 interview. “If he’s nominated by the president I’d be inclined to support him, I suppose, but that’s a long way from saying I’m urging the president. I’m not urging the president -- I’m not really thinking much about that.”
The process is politically more intricate than it might seem.
Powell and Quarles are like-minded lawyers with heavy finance experience. While the duo didn’t rip up tougher banking rules as some progressives had feared, they did oversee important relaxations that sanded down the edges of some of Wall Street’s most hated constraints -- such as stress testing and living wills.
The easing has been meaningful -- such as one move to free billions in derivatives collateral. But the bulk of their deregulation work went to benefit regional and smaller banks, not Wall Street.
Still, Democrats such as Senator Elizabeth Warren of Massachusetts want more vigilance, especially in areas such as shadow banking. Brainard’s resistance to the Powell-Quarles regulatory agenda, and her competence in everything from digital currency to international economics -- make her a compelling choice for some progressives.
“There is a very strong case” for Powell’s reappointment, said Sam Bell, founder of Employ America, a progressive research group in Washington. “But for some Democrats, Brainard could be a lot of what Powell is without being Powell on supervisory policy.”
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