Leadership transition at the Fed

Bottom line

Spoiler alert: President Trump will not nominate Jerome Powell for another term as Federal Reserve Chair when his current term expires in May 2026. Also, Darth Vader is Luke Skywalker’s father. 

But like a soap opera—or space opera—there have been, and surely will be, plenty of twists. How serious they get could potentially unsettle financial markets as this process unfolds over the next 10 months. Investors seem to be discounting the latest, in which an unnamed source said Trump showed legislators a letter saying he would fire Powell, only to have the president say it is “highly unlikely” a few minutes later. Surely, Trump recalls how the markets recoiled when he posted in April that “Powell’s termination cannot come fast enough!” 

Fed independence is sacrosanct We don’t want members of Congress or the president making monetary policy decisions for a host of reasons, most critically because most would opt to lower rates to goose the economy and enhance their own bids for re-election. The Fed’s dual mandate to keep the economy in a state of full employment and low inflation is extraordinarily difficult to manage. It would not take much interference to disrupt the delicate balance.

Mistakes were made But under Powell, his Fed has made a series of errors in recent years. Nominal annualized CPI inflation soared from 1.4% in January 2021 to 9.1% in June 2022, a 41-year high. It was apparent to us early in 2021 too much money was chasing too few goods in the post-Covid era. Powell and the Fed did not see it that way and did not raise rates.

After the shortest but deepest recession in US history ended after only two months in April 2020, the economy roared back to life. GDP grew substantially in the second half of 2020 and the first quarter of 2021. Yet, despite copious kinks in the supply chains due to the pandemic, Washington added trillions in unnecessary fiscal stimulus, sparking the surge in inflation. Chair Powell rationalized that the growing price pressures were “transitory.” The Fed neglected to raise interest rates until March 2022, perhaps a year too late. 

Fast forward to last summer. Inflation had receded sharply over the previous 24 months, and it was appropriate, in our view, to cut interest rates by a quarter point in July 2024. The Fed historically skips policy decisions after Labor Day in presidential election years to avoid the appearance of impropriety. So, we anticipated the next moves would be quarter-point cuts in November and December, after the election.

Instead, the Fed skipped the July meeting, instituted a super-sized half-point cut in September and still added quarter-point cuts in November and December. The timing, size and combination of those decisions raised eyebrows.

Core CPI continued to decline this year to a four-year low of 2.8% in May; core PPI fell to a 14-month low of 2.6% in June; and core PCE dropped to a four-year low of 2.6% in April. With the upper band of the fed funds target range still at 4.5%, we think there is plenty of room to reduce it by 150 basis points over the next 18 months. That would take the range to 2.75-3%. Yet, the Fed has adopted a wait-and-see approach, anticipating that the passage of Trump’s One Big Beautiful Bill and his tariff negotiations will push inflation sharply higher.

Working the refs Trump has been apoplectic in response to what he feels is Powell’s intransigence on lowering interest rates. Trump has argued that interest rates should be three percentage points lower, an argument with which we disagree. So, the president has resorted to his typical name calling, referring to the chairman as “Too-late Powell,” among other insults. Nothing has spurred the Fed to leave the sidelines. But despite the hullabaloo, we do not expect Trump to remove Powell, which we believe would roil financial markets again.

Much ado about nothing Further, we believe the brouhaha over the Fed’s renovation budget is a non-starter. Trump and others in the White House have suggested that Powell committed fraud by allocating more funds for the renovation of three historic Fed office buildings in Washington. Originally approved as a $1.7 billion project, they have grown to $2.5 billion. Accusing Powell of mismanaging the renovation or lying to Congress about its scope to justify removing him is not only baseless, but the markets would not look kindly at it.

End game, with a wrinkle? Far more intriguing is the how long Powell decides to stick around. His term as chairman ends in May 2026. A President typically nominates his choice about five months before this as the senate confirmation process can take a while. That would be December. But Powell’s term as a board member does not conclude until January 2028. Typically, the Chair steps down from the board as well, to avoid any possible market confusion, but are not required to do so. If Powell stayed, he wouldn’t just be a thorn in Trump’s side, there would be no opening on the board for a new governor, forcing Trump to choose from among the current members.

Back door However, the term of Adriana Kugler, a governor appointed by President Biden, expires in January 2026. We believe that Trump will nominate a replacement for Kugler shortly (August or September), and that person could well be positioned to replace Powell as Chair in May 2026.

Meet the candidates These are the half dozen most likely candidates:

• Kevin Hassett Director of the National Economic Council (NEC) and formerly the chairman of the Council of Economic Advisers (CEA) during Trump 1.0. Hassett worked at the Fed earlier in his career, and his Ph.D. in economics is from the University of Pennsylvania, Trump’s alma mater. He’s also very articulate with the media and appears to be right out of central casting for the eventual role as Fed Chair. Hassett is our top pick.
• Scott Bessent Secretary of the Treasury and a respected former hedge fund manager. He has an undergraduate degree from Yale University but does not have a Ph.D. in economics. Trump has toyed with the idea of having Bessent simultaneously serve as the Fed Chair and remain as Treasury Secretary, because he’s doing such an excellent job in his current role. Bessent is extremely articulate. But doing both jobs would be an encroachment on monetary and fiscal policy.
• Kevin Warsh A former member of the Board of Governors under Presidents Bush and Obama. He graduated from Stanford, earned a JD from Harvard and studied economics at MIT, but did not complete a Ph.D. He was a senior executive at Morgan Stanley in their M&A division. Warsh is a leading candidate for Fed chair, but he tends to lean hawkish.
• David Malpass Former president of the World Bank and the chief economist of Bear Stearns. He previously worked in the Treasury Department under Presidents Reagan and Trump and the State Department under President Bush. He has an MBA from the University of Denver.
• Christopher Waller A member of the Fed’s Board of Governors, he was formerly the director of research at the St. Louis Fed. He earned his Ph.D. in economics from Washington State University. Depending on how Powell handles his own seat on the Fed board, Waller could be under consideration for promotion.
• Michelle Bowman A member of the Fed board, she was recently promoted to the role as Vice Chair of Supervision, replacing Michael Barr. Before joining the Fed, she was the Kansas banking commissioner, and she earned her JD from Washburn University. Bowman is well suited in her current role.

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