President Donald Trump’s Nomination of Kevin Warsh to Become Fed Chair May Come With Unintended Consequences for Wall Street

The issue at hand for investors isn’t whether the Fed’s balance should or shouldn’t be reduced. It’s what might happen to the U.S. economy and stocks if Warsh gets his wish. If U.S. Treasury bonds and MBSs are sold, the expectation is that yields will rise. In simple terms, we’d be talking about higher long-term borrowing costs and less-affordable mortgages.

Even though the Federal Reserve is in the midst of a rate-easing cycle, the above actions have the potential to raise interest rates, thereby stymying economic growth. Investors are practically counting on lower interest rates to support a historically pricey stock market.

However, deleveraging the central bank’s balance sheet isn’t the only worry for Wall Street. Warsh’s conflicting ideology, based on his track record as a voting member of the FOMC, points to potential unintended consequences for the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite.

Historically, investors haven’t punished the Fed or FOMC too harshly for being fallible. Since the members of the FOMC are relying on backward-looking economic data when making their monetary policy decisions, it’s not uncommon for the central bank to be behind the curve when shifting its federal funds target rate (the overnight lending rate between financial institutions).

What investors aren’t willing to tolerate is a non-unified approach to monetary policy by the FOMC members setting it. Each of the last five FOMC meetings has had at least one dissenting opinion.

What’s noteworthy is that the October and December meetings featured dissents in opposite directions. Though the FOMC voted in favor of a 25-basis-point cut to the federal funds target rate in both meetings, at least one member favored no reduction, while another pushed for a 50-basis-point cut. Over the last 36 years, only three FOMC meetings have featured dissents in opposite directions — and two have occurred since late October.

Kevin Warsh would be taking over a historically divided FOMC. The concern is that Warsh’s monetary policy approach hasn’t always aligned with his voting peers. Using his voting track record prior to, during, and after the Great Recession as a guide, Warsh has consistently placed heightened emphasis on price stability and the prevailing inflation rate, and paid less attention to the unemployment rate.

Once again, I’m not taking sides and proclaiming this was the right or wrong stance from Warsh during a period of heightened uncertainty for the U.S. economy and stock market. Instead, I’m pointing out the expected ideological differences between Warsh and other voting members of the FOMC. Dissents may become even more pronounced under a Warsh-led Fed, which isn’t something that would go over well on Wall Street.

Admittedly, we’re a long way from proclaiming Kevin Warsh as the next Fed chair. He first needs a majority of the Senate Banking Committee to support his nomination, and this is far from a guarantee, with Republicans holding a slim 13 to 11 majority over Democrats. He’d then need a majority of votes in the Senate (51 votes) for confirmation.

But if Kevin Warsh can overcome these hurdles, stock market turbulence may follow.

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President Donald Trump’s Nomination of Kevin Warsh to Become Fed Chair May Come With Unintended Consequences for Wall Street was originally published by The Motley Fool