October 6, 2017 / 6:25 PM / a year ago

Warsh seen breaking from current Fed policy stance: Nomura

NEW YORK (Reuters) - A Federal Reserve led by Kevin Warsh would move the U.S. central bank away from its gradual approach towards raising interest rates and reducing its $4.5 trillion balance sheet, George Goncalves, head U.S. rates strategy at Nomura Securities International, said on Friday.

The former Fed governor is seen by traders as the current frontrunner to succeed Janet Yellen as head of the Fed, whose term expires in early February.

“We believe that a Warsh Fed would be the most interesting and a clear shift from the way the Fed is currently run,” Goncalves wrote in a research note.

Nomura’s economists assigned a 40 percent chance President Donald Trump would pick Warsh as the next Fed chief; that was followed by current Fed governor Jerome Powell at 20 percent. Powell was believed likely not to stray far from the Fed’s current policy stance.

Meanwhile, they placed a 20 percent chance on Yellen being reappointed, a 10 percent chance for National Economic Council director Gary Cohn, and 10 percent for other candidates.

Among areas Warsh may deviate from Yellen was that he would unlikely “waver as much” if the stock market corrects from their record high levels. This compares with Yellen and her predecessor Ben Bernanke who have been sensitive to gyrations in financial conditions, according to Goncalves.

A Warsh tenure as Fed chief also leaves open the possibility for a faster pace of shrinking the Fed’s balance sheet, especially with the reduction of its holdings of mortgage-backed securities, he said.

Moreover, Warsh, whom some traders speculated resigned in 2011 as Fed governor in protest of the central bank’s second round of bond purchases, would be less likely to expand the Fed’s balance sheet through quantitative easing (QE) again in the future, Goncalves said.

That said, long-term risk premia in the bond market would not fall as much because Warsh would be less prone to embark on QE to combat a recession or a financial crisis.

“With Warsh, that pricing should drop and result in higher term premia as the hurdle for more QE gets hiked,” Goncalves said.

Reporting by Richard Leong; Editing by Bernadette Baum

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