US President Donald Trump has picked a 'safe pair of hands' for Fed chair, the last thing markets expected.
Nominating Kevin Warsh as the next chair of the Federal Reserve was not in the script.
Trump wrong-footed the markets at the back end of last week (30 January) by picking someone who was not considered to be a strong contender to replace Jerome Powell.
The conventional thinking since Trump returned to the White House was he would appoint a close ally who would loyally push for ultra loose policy to stimulate the US economy.
Treasury Secretary Scott Bessent was an early front runner before being overtaken by Trump economic adviser Kevin Hassett and BlackRock fixed income head Rick Rieder, a financial media star in the US who too fell by the wayside.
Questions remain over whether Warsh offered some assurances to Trump that he will work towards lower rates. It is clearer though that he will likely approach the job with a healthy dose of scepticism over exactly how far and fast to move.
Warsh, a former banker and member of the Fed board of governors, is widely considered to be a monetary hawk. He is known to be wary of overly loose central bank policy, the associated inflation risks and was highly critical of the excessive quantitative easing seen during the Covid-19 pandemic.
The news has kicked the legs out from under the dollar 'debasement trade' which has sent gold, silver and other metals on a stratospheric rise, at least temporarily.
Monetary policy is the most delicate of balancing acts and one way to look at the decision is as a safe pair of hands. The big fear for investors, and perhaps some of those advising Trump, was a perceived loss of Fed independence that picking an ultra dove who would follow orders from the White House would imply.
Such a scenario may have accelerated the debasement trade in the short run, but may well have led to resurgent fears of runaway inflation and turmoil in the markets. This would be the opposite of what the administration wants ahead of the mid-term elections in November.
Warsh's impending arrival may force a rethink for money managers who had been positioning for continued downward pressure on the dollar.
Syz Group chief investment officer (CIO) Charles-Henry Monchau said: "While the appointment had been flagged as a possible outcome in policy circles, its official confirmation acted as a catalyst for a rapid repricing across asset classes."
Monchau described the ‘Great Metal Flush' as "the result of speculation colliding with institutional pressures" powered by "weeks of optimism for precious metals had been fuelled by a narrative trap; the widespread expectation that a dovish Fed chair would replace Jerome Powell".
"That narrative collapsed in what became known as the 'Warsh Shock', when a chair was appointed with a relatively orthodox approach to monetary policy and a bias to reduce the Fed's balance sheet — moves that could negatively affect market liquidity," he added.
Monchau added that despite the turmoil, gold's long-term technical structure remains intact. The dramatic moves seen in the last few days said more about positioning and narrative shock than about a fundamental deterioration in the macro outlook.
"Labelling Warsh a hawk, however, risks missing the bigger picture," he continued. "His framework is more nuanced and arguably more market-friendly than the initial reaction suggests."
Central to his thinking, according to the CIO, is the idea that the US economy is entering a phase of sustained productivity gains, driven in part by technological progress.
"January's market narrative was built on the idea of a weakening Fed, aggressive rate cuts, and a structurally softer dollar and Warsh's nomination disrupted that consensus, as he was not the front-runner."
Fairview Investing director Ben Yearsley said: "It is an interesting one, as at first glance it looked like a weak dollar, hence soaring gold, as that is what Trump wants. Then Warsh's history on controlling inflation became the narrative and the dollar rebounded."
He added that no one actually knows what Warsh will do. The reality is probably similar to Powell; a few cuts but "nothing out of the ordinary".
"For portfolios, it does not change the supremacy of the US markets and the AI trade," Yearsley added.
This article originally appeared on PA's sister title Investment Week
