The Fed: Contemplating Chair Waller

Discussion

In the SPX outlook last November I wrote at length about the need for Powell to engineer a recession in 2025 in order to bring inflation durably back to target ahead of the termination of his chairmanship on May 15, 2026. Key to this thesis was that the next FED chair would quickly dismantle his work on bringing inflation back to target, as a re-elected Biden would have every incentive to let fiscal rip in a second term without a hawkish FED chair impeding his agenda…and we are all well aware of Trump’s disdain for high interest rates generally and Powell specifically.

But, if Powell is reappointed or replaced with someone aligned with his “opportunistic disinflation” monetary policy philosophy, that would alter the financial market landscape for 2025.

Today WSJ Nick Timiraos penned what amounted to a soft landing victory lap, praising FED Governor Waller for his prescient forecast in mid-2022 that the Fed could cool the labor market with aggressive rate hikes through the job openings channel and on the other side avoid a spike in unemployment with a careful calibration of policy. We’ll see what happens, but so far Waller, and by extension Powell, has/have been correct. However…

The most important part of the piece was the revelation Waller is under consideration to replace Powell on May 15, 2026 if Trump is elected. Given Trump’s love of deficits and low rates, honestly a Waller appointment to FED chair would shock me because Waller and Powell are simpatico on monetary policy. But today’s Timiraos piece seems like a very intentional planting of key information.

If Waller is appointed to FED chair then Powell can absolutely maintain the “opportunistic disinflation” policy currently in place all the way through until May 15, 2026. Knowing Waller will take over and not destroy his legacy by letting inflation rip, Powell can sit there with Fed Funds at 525-550, threaten to hike more if inflation reaccelerates, keep the balance sheet and the threat of rate cuts sitting beneath the labor market and financial market stability, and continue running down the balance sheet well beyond what dovish market participants believe is likely.

In my opinion, managing the economy in a “band” by toggling FCI up and down every 2-4 months in response to economic conditions is allowing above-target inflation to become embedded in the US economy, which will manifest itself in a reacceleration of inflation in the back half of 2024 (if that reacceleration isn’t already in the room with us now), leading the Powell Fed to resume rate hikes at the December 2024 FOMC to get inflation durably on a path back to 2%. A resumption of hikes will likely entail the US economy entering recession, but it will unlikely be the FED-engineered recession I originally envisioned for 2025 ahead of the end of Powell’s term in May 2026, and thus more manageable from a financial market perspective. Instead of declining to 10x cycle-peak $220 EPS in 2025, I could see SPX falling to 15x $220, or circa 3300.

But if inflation simply stabilizes in the 2.5-3.5% range, it’s likely Powell will just sit there at 525-550 until May 2026. Perhaps AI can overwhelm the economic impact of “higher for longer” monetary policy, but if it cannot, once the market gets past the Yellen/Brainard POTUS Election Year Put the S&P 500 can revert to a best-case fair value of 17x $250 EPS circa 4375, or a more realistic fair value of 17.5x $200 EPS circa 3500 that better accounts for lower corporate profit margins.

Article Exhibits

Second paragraph in…

Waller’s meeting with Trump.