Warsh pick doesn't end talk that Powell could stay on to defend the Fed's independence

By Greg Robb

Former Fed official says Warsh may have to convince his predecessor he can leave

President Donald Trump has settled on Kevin Warsh, left, as his nominee to replace Jerome Powell - whom Trump also picked, late in the first year of his first White House term - to chair the Fed.

With Kevin Warsh as his Fed-chair pick, President Donald Trump was hoping that he had put his stamp on the central bank and put the current Fed chair, Jerome Powell, in the rearview mirror. But some Fed watchers say that it isn't that simple and that, by selecting Warsh, Trump may have made it more likely that Powell will continue to stand in Trump's way.

Powell has the option to stay on the Federal Reserve's Board of Governors until 2028 after his term as chair ends in May. It would be unusual, but not unprecedented, for him to remain. Now, with Warsh, who has been a fierce critic of the Powell Fed poised to take the helm, Powell may feel motivated to stay to ensure the Fed's continued independence, amid continued pressure from Trump on the central bank to lower rates.

'I think Powell feels a duty to stay on, even if reluctantly, [as] it would be unusual.'Derek Tang, LH/Meyer Monetary Policy Analytics

While no one knows for sure, "I think Powell feels a duty to stay on, even if reluctantly, [as] it would be unusual," Derek Tang, a top Fed watcher with LH/Meyer Monetary Policy Analytics.

If Powell truly holds Fed independence in the high regard that he says he does, this is the best way to defend it, Tang added.

Powell would probably have left if Trump had selected Fed governor Christopher Waller, who was one of the front-runners for the chairmanship, Tang said in an interview with MarketWatch. Waller has been working in the Fed system since 2009 and has written numerous papers on the importance of shielding the Fed from political pressure.

Powell's staying would have real consequences for the White House's latitude to influence the Fed. It deprives Trump a majority on the Fed's seven-member board, and makes substantial institutional overhaul less likely.

Powell's having left his option open has already constrained Trump in an important way. Trump has to use the expiring Fed board seat held now by his close ally Stephen Miran in order for Warsh to join the Fed because there are no other vacant seats.

Some analysts think Powell will leave in the end. "I lean towards thinking Powell goes," said Ian Katz, managing director of research firm Capital Alpha.

Extraordinary pressure

Powell will be making his decision amid extraordinary and unusual pressure from the White House on the central bank and on Powell himself. The public bullying by Trump and his political allies, which is unlike anything previously seen, is likely pushing Powell toward staying on, said Mark Spindel, chief investment officer of Potomac River Capital, and an author of a book on the Fed's independence.

'I believe Powell feels the institution is under threat because he's under threat.'Mark Spindel, Potomac River Capital

"I believe Powell feels the institution is under threat because he's under threat," he said.

The Trump administration has begun a criminal investigation into what Powell told Congress about cost overruns on the central bank's renovation of its headquarters. Trump's critics, alongside Powell himself, have characterized the announcement of that investigation as nakedly politicized and imperiling to central-bank independence.

Washington Watch: Here's how Warsh's Senate confirmation is likely to go as a key Republican threatens to block it

The White House is arguing at the Supreme Court that it has the right to fire Fed governor Lisa Cook for a cause only determined by the president. If Trump wins that case, he could pack the Fed with allies and get the overhaul he wants.

Powell's staying on the board is his only leverage to push back. In essence, Powell and Trump are still negotiating, and the tension between the two is palpable, Spindel said. "Powell hasn't made up his mind because he doesn't have to make up his mind yet," Spindel said.

Warsh is backing substantial change

Warsh served on the Fed board from 2006 until 2011 but left after disagreement with then-Fed chief Ben Bernanke's decision to buy assets to foster lower interest rates, commonly called quantitative easing, or "QE," even though the worst of the financial crisis had passed. Warsh said the purchases would distort markets and cause inflation.

Over the past 14 years, Warsh has been a consistent critic of the Fed, often in caustic terms.

Warsh wants to shrink the size of the Fed's $6.6 trillion balance sheet, which would decrease the Fed's footprint in financial markets.

Powell, who joined the Fed in 2012 shortly after Warsh left, has championed a larger balance sheet as a way to mitigate financial crises.

"Warsh has been quite critical and seems to promise substantial institutional overhaul," former Fed governor Donald Kohn wrote in an email to MarketWatch.

It's hard to say what Powell will do in May, he said. "It's really up to Kevin to convince Jay that any changes he has in mind will preserve independence and enhance the effectiveness of the staff and the reserve banks," Kohn said.

"The choice of Warsh could influence Powell's decision on whether he stays or not, but i don't know which way it would influence him. It could go either way," Katz said.

"There is a certain amount of psychology going on in predicting this. It is not an economic or market analysis. It's guessing what's in the mind of one individual," he added.

The issues surrounding use of the balance sheet are complex but matter to the average investor, Spindel said.

The Fed's balance sheet grew because the central bank bought assets to control the level of mortgage rates and keep long rates down so borrowing was possible. The Fed also propped up the state- and municipal-bond markets and provided more runway and foam for a softer landing for the economy.

All in all, this was an effort to shield Main Street from Wall Street's financial crisis, and has it been huge beneficial for average Americans, Spindel said.

Spindel said some of the dynamic of Powell's feelings about Warsh spilled into the open at Powell's press conference last Wednesday, Spindel said.

When asked if the Fed's models were inadequate, which has been one of Warsh's criticisms, Powell pushed back. "I mean, if it's a question of using better models, bring them on," Powell said. "Where are they?"

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