It’s the most important job in finance, but the focus falls on whether Jerome Powell, whose term as Fed Chair expires in Feb 2022, is reappointed or whether he is replaced by Lael Brainard, or perhaps even Raphael Bostic. The earlier talk was this decision was slated before Thanksgiving (25 Nov), but the WSJ reported this week that the nomination could be announced over this weekend. The question then of gapping risk for the Monday open is one traders should consider.
As the well-used term goes, markets hate uncertainty – and a Brainard appointment, at a time of impending monetary policy change, represents a small rise in uncertainty that many in the market could do without – well, except for those who like volatility which is most short-term traders.
A wild December
Still, my base case is we are headed into a period of higher volatility regardless, with a wild December ahead of us. Where we see the US Treasury exhausting measures by mid-December and the US debt ceiling potentially becoming problematic, just as the FOMC meeting (16 Dec) sees the central bank likely announce they are accelerating the pace of tapering from $15b to $20-$25b.
Expectations of volatility from the Fed meeting should increase after the Nov non-farm payrolls (4 Dec) and then the Nov CPI print (11 Dec) – the latter a genuinely market-moving event.
With the Fed due to ramp up the pace of tapering and potentially closing out its QE program far earlier than prior calls for mid-2022, it sets us up for the Fed to start hiking in July or August. The markets currently price just over two hikes over the coming 12 months.
Is this the time to change captain?
The concern the market naturally holds then is whether this is really the time to be changing the captain of the ship when we’re charging towards choppy waters? And, if the public have such great disdain for inflation - and US inflation is only getting hotter - why replace Powell with someone who most know is slightly more dovish?
Brainard, in some market participants minds, could further slow the reaction function of the Fed and rising talk of the Fed being “behind the curve” could see volatility rise. OK, we know Brainard is a Democrat, and we know she is genuine Fed chair material, but when inflation is probably the number one point of contention and the Mid-term elections is in our sights, surely it makes little sense to allow inflation to run even hotter.
A Brainard appointment may change the focus to one where the employment mandate is aimed at a greater inclusion – so, despite the headline employment rate headed to 4% in Q1 22, there could be a shift towards more targeted groups and at a simplistic level that could mean keeping rates lower for longer.
In some eyes, when inflation is running hot, not just through supply-side issues, but through demand and wages, then rates simply need to go higher, and Powell is more likely to address this sooner.
I am not so sure I share the market’s concerns, and I feel Brainard would be no less dovish than Powell, but this is a widely held view in certain circles.
Betting sites have Powell as the firm favourite
We can see the odds of Brainard getting the gig have beefed up after what was seen as a very positive meeting with the President recently. And we know there have been calls for change at the helm given the recent spate of controversial trading cases at the Fed. While progressives want tougher financial regulation and a Fed that can use policy to address climate change.
Despite Brainard’s odds increasing, the market is clearly leaning that Powell gets a second term, and for what it’s worth, I think he should get the gig. The betting markets have Powell as chair at 76% (69% on Predicit) and that is fair, but there is a non-immaterial chance that we do see Biden nominate Brainard, so it certainly needs monitoring.
If Lael Brainard does get nominated then the first place to look is short-term US Treasuries, and I’d expect 2-year yields to fall 3-4bp. If yields drop then the USD should follow, especially vs higher beta plays (AUD, NZD, MXN), while we may see some selling in US500 and US2000, with outperformance seen in the NAS100. Gold would probably find buyers and may even take out the recent highs of $1870.
Given recent moves in rates and the bull move in USD, I’d argue the market is strongly leaning on a Powell reappointment, so news of him getting the gig may cause limited moves on open – if we do indeed see it announced this weekend.
Still, it’s a risk to monitor – but the real issue remains to navigate the event risk in December in what is typically a period of lower participation.
