Federal Reserve Chairman Jerome Powell's renomination seemed like such a lock a few weeks ago that most Fed watchers thought any discussion of a central bank leadership shake-up was a waste of breath.
Ethical concerns raised by Fed officials' personal trades seem to have changed all that.
Market watchers are saying Powell still has a good chance of getting reappointed, but the odds have gone down from earlier this year.
"It is still Powell's job to lose, but he might be losing it," said Edward Mills, a managing director and Washington policy analyst at Raymond James & Associates Inc.
After their stock trades in 2020 raised ethics concerns, Federal Reserve Bank of Boston President Eric Rosengren and Dallas Fed President Rob Kaplan retired. Vice Chair Richard H. Clarida of the Board of Governors moved an amount between $1 million and $5 million from a bond fund to an equity fund in February 2020, a day before Powell announced potential policy action to combat financial turmoil stemming from the COVID-19 pandemic, according to a recent Bloomberg News report.
A Fed spokesperson said the central bank has "asked the inspector general to look at recent transactions for their compliance with ethics and law." The spokesperson declined to comment on whether the Fed plans to take action in light of the reports about Clarida.
Odds still in Powell's favor
Edward Moya, a senior market analyst with OANDA, said he sees a 70% chance of President Joe Biden renominating Powell before his term is set to expire in February. There was a nearly 100% chance back in early September.
PredictIt, an online political futures market, had Powell's chances of being reconfirmed by the Senate as high as 90% on Sept. 12. Those chances fell to 61% on Sept. 28, the day after Kaplan and Rosengren announced they were leaving their posts. On Oct. 7, PredictIt put the odds of a Powell renomination at 69%.
Isaac Boltansky, director of policy research and a managing director at BTIG LLC, said Powell is still more likely to be renominated as chair.
"The odds of Powell being renominated were up near 90% before the Kaplan and Rosengren news, and then the Clarida news makes it even worse," Boltansky said in an interview. "I still think it's over 50%. But the trading dynamics have atrocious optics that impact the politics surrounding the Fed in general and the forthcoming slate of nominees in particular."
Powell's potential ouster could trigger a sell-off in equities, flatten the Treasury yield curve and cause a spike in market volatility, Moya said.
"Markets hate uncertainty," Moya said. "That type of shake-up would be very disruptive."
Lael Brainard, another member of the Board of Governors, has been widely viewed as Powell's most likely replacement, but Brainard may also be impacted by the trading scandal due to her role as the chair of the Board of Governors' Committee on Federal Reserve Bank Affairs, said Brian Gardner, chief Washington policy strategist at investment bank Stifel.
"If the controversy over the trades tanks the candidacies of both Powell and Brainard then an outsider could be in line for the Fed job which could be the worst outcome for markets since it would probably be a surprise and would put someone at the top of the Fed with whom markets are less familiar than either Powell or Brainard," Gardner wrote in a note. "Alternatives to Powell and Brainard would likely be more dovish on monetary policy and aggressive on banking regulation."
After the trading disclosures but before the retirement announcements, Powell directed the Board of Governors staff to review ethics rules related to senior officials' financial holdings and activities.
"The review could have an impact and arguably is already having an impact on Powell," Mills of Raymond James & Associates Inc. said in an interview. "The question for me is: Does the review need to be completed before he can get a renomination, or does the review create a situation where Biden is pushed into another selection for chair of the Federal Reserve?"
Other changes to the Board of Governors
Fed watchers believe they will get early insight into Biden's plans for the Fed on Oct. 13 when Randal Quarles' term as vice chairman for supervision expires. Biden could nominate Brainard to fill that role, Gardner said.
This change would likely increase regulatory pressure on banks, said Peter Cecchini, director of research at Axonic Capital.
"She's taken great pains to dissent numerous times on liquidity and bank capital requirements," Cecchini said.
By January, Biden is expected to replace Clarida and is expected to fill an already empty board seat.
Biden is expected to use the nomination process to fill the board with nominees aligned with his goals of addressing climate change and economic disparity, particularly along racial lines.
"I expect nominees to be dovish and racially diverse, likely with somewhat non-traditional backgrounds," said Michael Crook, deputy chief investment officer with Mill Creek Capital Advisors. "Around the dovishness, I believe it will manifest as fully embracing the Fed's new operating framework."
