In the latest update on Trump's search for the next Fed Chair, Reuters reported that the search has narrowed down to 5 finalists - Yellen, Warsh, Taylor, Powell and Cohn (condolences to Jeff Gundlach: his dark horse candidate, Neel Kashkari did not make the cut) - and that after meeting Yellen on Thursday, Trump will have discussed the Fed job with all five candidates. More importantly was the news that Trump is expected to announce his decision for next Fed Chair in the next 2 weeks, before he leaves for his Asian trip on November 3.
- YELLEN, WARSH, TAYLOR, POWELL AND COHN ALL CANDIDATES FOR FED CHAIR -WHITE HOUSE OFFICIAL
- FED CHAIR SEARCH NOW NARROWED TO FIVE FINAL CANDIDATES, WHITE HOUSE OFFICIAL SAYS
- AFTER YELLEN MEETING, TRUMP WILL HAVE DISCUSSED FED JOB WITH ALL FIVE FED CANDIDATES -WHITE HOUSE OFFICIAL
- TRUMP EXPECTED TO ANNOUNCE FED DECISION BEFORE HE LEAVES FOR ASIA TRIP NOV. 3 -WHITE HOUSE OFFICIAL
Yesterday, the USD and bond yields turmoiled briefly following news that Trump had warmed to the candidacy of San Fran professor John Taylor, father of the Taylor Rule and advocate of rules-based monetary policy, and who is widely perceived as a mega hawk. The news sent the USD surging and hit bonds.
That said, Taylor's hawkishness appears to have worked against him, and after surging to 2nd spot on Predictit yesterday, Taylor was tumbled to 4th spot this morning.
That said, Taylor's hawkish reputation may be unwarranted. As SocGen's Kit Juckes wrote this morning, what rate the Taylor Rule indicates is dependent on a variety of assumptions. To wit:
President Trump is reported to have taken away a favourable impression of John Taylor after he met the Stanford University economist and inventor of the ‘Taylor Rule'. As the President ponders who to appoint as the next Fed Chair, he now only has Janet Yellen to meet with, and Professor Taylor is the new market favourite. That, in turn, has given the dollar a bit of support and sent yields a bit higher as everyone contemplates what the Taylor Rule would imply for monetary policy. It's generally concluded that a rules-based approach would deliver higher rates faster than we would see under the current policy framework.
Anyone armed with a Bloomberg terminal can type in TAYL GO and see where a Taylor rule estimate of appropriate rates is, and if they want, they can play with the critical elements of the rue - the estate of ‘neutral' real rates, NAIRU, and the inflation target. On the basis of a 2% neutral real rate, and a 4% NAIRU, the Fed is a long way behind the curve, which may be reason enough to think that a Taylor Fed would be more hawkish. On the other hand, lower the NAIRU (which may be reasonable given what we've seen from the labour market data in recent years) and you can get that estimate down. A 3% NAIRU throws out a 1.5% Funds rate, for example. And if Professor Taylor really wants to fine-tune his rule, he can head down the road from Stanford to the San Francisco Fed, 36 miles away, and have a chat with Stanford alumni and head of the San Francisco Fed, John Williams. He developed an estimate of neutral rates with Thomas Laubach, which moves over time and is currently at -0.2%. See Professor's comments on a debate about that here . Plug Williams-Laubach's R* into Bloomberg's TAYL function with a 4% NAIRU and rates ‘should' be 0.5%. Now cut NAIRU to 3% and we're at -0.75%. By way of indication, I've plotted some variants of this below, though I haven't adjusted the Wiliams-Laubach R* all the way through the time series so they are only relevant in the recent past. The lesson is clear however - the rule's just a rule, it's how it's used that matters.
Choose your rule - but neither R* or NAIRU are necessarily constant through time
For now, however, Taylor's hawkish reputation precedes him, and - for a president who realizes he needs rates as low as possible for as long as possible - that will hardly boost Taylor's application. In fact, as we noted yesterday, the most likely outcome at this point is that Trump simply asks Yellen to continue for one more term.