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 during up a lot of speculation the Wall Street and in Washington.
It's this idea of a Shadow Fed Chair.
It's Monday, July 21st 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, markets, and you will see that President Trump has been critical The 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, a market pricing suggests the policy rate of just above 3 % by the end of next year.
That level is lower than the current fed rate of 4 .0 to 4 .5, but not aggressively so.
In fact, Morgan Stanley's base case is that the policy rate is even going to 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.
As reports suggest, we will get a name by late summer though.
Another key point for my perspective is even when Powell's term as chair ends, the Feds reaction function, which is to say, how the Feds reacts to incoming economic data, well it's probably not going to change overnight.
The Federal Open Market Committee, or 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 Just 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 off as 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 of this, so for now it's just to 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 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.
So where does all of this leave us?
For now, this Shadowchair debate is more of a nuance in the primary narrative.
We don't expect the Feds 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 is in 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 this show, please leave us a review wherever.
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