President Trump intends to nominate Stephen Moore and Herman Cain to open positions on the Board of Governors of the Federal Reserve; however, formal nominations have not yet occurred and confirmation by the US Senate is far from assured. The appointment of two new Governors to the Federal Reserve could have impacts on the conduct of monetary policy and on market responses, but it is likely that the direct impacts would be modest.

This President's nominations to the Board could have much more significant impacts on the outlook for Fed policy should he win a second presidential term, which would allow him to replace the Chairman, Vice Chairman, and Vice Chairman for Supervision and possibly other members on the Board of Governors.

Key issues are how markets and the broader public might respond if Federal Reserve policies were to be seen as influenced by partisan objectives, and whether messaging to markets would be impeded if the FOMC is comprised of members with vastly different, and in some cases unorthodox, views about how to conduct monetary policy

Status and prospects for approval

Nominees to the Board are subject to confirmation by the full US Senate, based on a simple majority. On the surface, it would appear that the Republican majority in the Senate implies a high likelihood of confirmation. However, a handful of Republican senators (and some Democrats, perhaps less surprisingly) have expressed reservations about one or both of the President's Fed choices, because of concern that they may be viewed as overly partisan, possess insufficient experience pertinent to Fed service, have unorthodox views about Federal Reserve policy, or due to other issues.

Both candidates have expressed views on Fed policy that are controversial. Stephen Moore has sharply criticized the Powell Fed for past rate hikes, argued that it should cut rates immediately, and suggested that that a "tone-deaf" Powell should resign as a result of "disastrous" policies. In 2015, he advocated abolishing the Federal Reserve. As recently as last month, Mr. Moore advocated using monetary policy to target an index of commodity prices. Herman Cain advocated the return to a gold standard. Both suggestions fall well outside of monetary policy orthodoxy and are likely to be received with some skepticism in the Senate.

To be clear, diversity of thought is not necessarily an impediment to successful Fed leadership. More troubling, perhaps, these individuals could be seen as influenced by partisan objectives, in contrast to the expressly non-partisan stance of the Federal Reserve. Whether concerns over controversial policy views, potential partisanship, the lack of policy experience, or other issues translate into insufficient support for confirmation remains to be seen.

Influence on policy of two new Governors

The appointments of Cain and Moore to the Board, if they occur, could have some influence on monetary policy, but their more controversial suggestions will gain no traction on the Board or within the wider Federal Open Market Committee (FOMC). Nevertheless, they could have notable influences on policy through positions as voting members on the Board and on the FOMC. There is zero support within the Federal Reserve for using monetary policy to target commodity prices, whether a single commodity, such as gold (Cain), or a basket of commodities (Moore).

Nevertheless, they could have notable influences on policy through positions as voting members on the Board and on the FOMC. The Board of Governors oversees banking supervision and regulation, determines the setting of the Countercyclical Capital Buffer for banks, and an affirmative vote of 5 of 7 Governors is required to enact emergency lending programs. As two voting members on a seven-member Board (when at full strength), Messrs. Cain and Moore could influence policy decisions within the Board's purview. Their influence on the much larger FOMC would seem to be more diluted but not inconsequential. Hypothetically, they could help to tip the voting balance on a divided FOMC in favor of a lower path for the federal funds rate.

Longer term: Impact of the 2020 Presidential election

Longer term, the President might have substantial ability to influence the composition of the Board, and by extension, policy decisions, with the obvious proviso that all nominations are subject to Senate confirmation. In addition to the two current, open positions on the Board, during the next presidential term, there will be at least three more opportunities to alter Fed leadership.

If President Trump were to be re-elected and even if all current Governors serve out their full terms as Governor, the President will have at least one more opportunity to nominate a new member to the Board (to replace Clarida), if the President so chooses. Furthermore, within the first 13 months of the next Presidential term, all 3 leadership positions on the Board will turn over: Chairman, Vice Chairman, and Vice Chairman for Supervision. It is conceivable that all three of the individuals currently in those positions, if they are not renominated, could resign from the Board (Powell and/or Quarles) or will be termed out from the Board (Clarida), creating the possibility that up to 3 Governors will be replaced between October 2021 and February 2022. Clearly there is an opportunity for nearly wholesale changes to the Board between now and 2022.

Market reaction and economic impacts

It is challenging to project how a Board with a majority of members nominated by President Trump might act. If the nominations of Moore and Cain are to be indicative, there are grounds for concern that the Board could become influenced by partisan objectives, especially after early 2022.

Another risk is market confusion stemming from mixed messaging by Federal Reserve policymakers with different and potentially unorthodox views about how to conduct monetary policy. It is conceivable that the risk of mixed messaging that weakens the Fed's ability to guide expectations would be greater when some policymakers are seen as influenced by partisan objectives.

Market reactions are difficult to anticipate. If markets (and the broader public) were to come to believe that policy decisions will be influenced by partisan objectives, the Fed's credibility as an objective, non-partisan economic steward could be questioned.

One risk is an un-anchoring of inflation expectations that could lead to more volatile (and potentially higher) interest rates. A loss of credibility could result in higher borrowing costs for private borrowers and the US Treasury. At times, the Federal Reserve may be called on to take difficult and even controversial decisions, such as implementing emergency lending programs during a financial crisis. A Federal Reserve that is seen as influenced by partisan concerns might have less "expert authority" and could find it more difficult to gain support for such decisions from lawmakers and the public.

Mitigating these risks is the enormous reserve of objective non-partisanship within the Federal Reserve System, institutionally and specifically within the ranks of current Fed leadership. It is important to note that the FOMC is, by tradition and by design, a consensus-driven deliberative body. It is likely that even after early 2022, a majority of voters on the FOMC and a very substantial majority of the entire FOMC (voting + non-voting) will not have been nominated by the current US President or will continue to act with fealty to the principle of objective non-partisanship. Finally, it is critical to recall that the Federal Reserve is answerable not to the President specifically or to the Executive Branch, but to Congress. Specifically, the "dual mandate" requiring the Federal Reserve to pursue both price stability and maximum employment is assigned to it by Congress.

Posted 11 April 2019 by Ken Matheny, Executive Director, Research Advisory Specialty Solutions, S&P Global Market Intelligence