For months, bond investors have been betting that a successor to Federal Reserve Chair Jerome Powell would push for interest rate cuts. Now, with President Donald Trump's decision potentially imminent, those bets are about to face a significant stress test. Over the past year, the market has largely assumed that all four final candidates for Fed Chair would acquiesce to Trump's repeated calls for lower rates. Driven by this expectation, short-term U.S. Treasury yields have consistently outperformed their long-term counterparts. This phenomenon, known as "yield curve steepening," reflects the market's view that while cuts to the U.S. benchmark rate would enhance the appeal of short-term Treasuries, they would simultaneously fuel inflation expectations, thereby negatively impacting long-term bond performance. Furthermore, if investors grow concerned that Trump's nominee could undermine the Federal Reserve's independence, the market might counteract the intended economic stimulus from official rate cuts by pushing up borrowing costs, potentially leading to increased price pressures. "We are all trying to read the tea leaves on the developments," said Gennadiy Goldberg, Head of U.S. Rates Strategy at TD Securities. "It appears that one key criterion for nomination is that the candidate must hold a sufficiently accommodative policy stance. This is a very important point." Market perceptions regarding the dovishness of each candidate vary, causing the implied odds of each candidate's success to fluctuate as investors scramble to adjust their positions. A market tremor occurred just last Friday when Trump signaled reluctance to appoint Kevin Hassett, who was previously considered a frontrunner perceived as leaning dovish. This signal triggered a sell-off in U.S. Treasuries, and market pricing for Fed rate cuts this year adjusted downward to fewer than two. Investors caution that the immediate market reaction to the nomination announcement might be relatively muted, considering that monetary policy is set by the twelve members of the Federal Open Market Committee (FOMC), not by the Chair alone. Despite growing external concerns about the Fed's political independence, the prevailing market view is that none of the four candidates individually poses a significant risk. "They all have the relevant track records," said Michael Cudzil, Chief Investment Officer for Public Markets at Allianz Global Investors. "None of them are the type that would cause market tremors." Powell's resistance to a Department of Justice probe, coupled with public support from some Senate Republicans, could complicate the nomination process, highlighting the constraints any successor would face. Powell could even remain on the Fed's Board of Governors, thereby limiting Trump's ability to reshape the FOMC. Against this backdrop, the following outlines the potential bond market reactions to the possible success of the four candidates: Kevin Hassett, former Fed Governor Kevin Warsh, Fed Governor Christopher Waller, and Rick Rieder, Head of Global Fixed Income at BlackRock. Kevin Warsh As of 4 p.m. New York time on Thursday, prediction market platform Polymarket showed his nomination probability at 44%. Warsh is viewed by many as the relatively more hawkish candidate among the four; his appointment would likely push Treasury yields higher. Economists including Krishna Guha from Evercore ISI noted in a recent report that Warsh might also pursue a policy mix of "balance sheet reduction + rate cuts," a combination that could also lead to underperformance in inflation-linked long-term Treasuries. During his tenure as a Fed Governor from 2006 to 2011, Warsh sometimes called for rate hikes and frequently warned about inflation risks—a concern he reiterated last year—even as other officials focused on addressing the economic fallout from the financial crisis. However, Warsh later shifted to support lowering borrowing costs, partly due to his belief that advancements in artificial intelligence could significantly boost productivity. He has also explicitly advocated for a substantial reduction in the Fed's balance sheet size and more aggressive quantitative tightening. His comments suggest a desire to diminish the central bank's dominant role in markets, a view shared by U.S. Treasury Secretary Scott Bessent. The Evercore ISI report suggested that, based on expectations of productivity gains, Warsh might lean towards further rate cuts to offset the tightening effects of balance sheet reduction. Rick Rieder Nomination probability: 32%. Ray Attrill, a strategist at National Australia Bank, said investors would likely initially categorize Rieder as dovish, partly because his stance on Fed policy is not yet widely known. He indicated that the market's instinctive reaction could be a weaker U.S. dollar and a steeper U.S. Treasury yield curve. As a dark horse candidate gaining momentum later in the process, Rieder's advantage partly lies in the Senate potentially being more willing to confirm his appointment. This month, Rieder stated that against a backdrop of "solid" economic growth but a softening labor market, two rate cuts this year, bringing rates to around 3%, would be "appropriate." Rieder called Fed independence "critical," but he also echoed Bessent's view that the central bank could be more "innovative" in how it manages its balance sheet. Stephen Miller, former Head of Fixed Income Markets for Australia at BlackRock and now an advisor at GSFM, said Rieder's extensive tenure at BlackRock, helping manage $2.4 trillion in fixed income assets, would bring a market-oriented perspective to the role, potentially helping to alleviate concerns about Fed independence. However, due to the significant uncertainty surrounding Rieder's policy leanings, traders might adopt a wait-and-see approach. "Rieder ranks highly on credibility," said James Athey, Investment Portfolio Manager at Marlborough Investment Management. "But we know very little about his policy views." Christopher Waller Nomination probability: 13%. Waller, who joined the Fed Board in 2020, has a notable track record in monetary policy: he correctly predicted that the Fed's post-pandemic tightening cycle could curb inflation without triggering a recession. Last year, as the labor market weakened, Waller voted in favor of rate cuts, a stance later validated. In December, Waller stated that the current policy rate remained 50 to 100 basis points above the neutral rate—the level that neither restrains nor stimulates the economy—a view broadly consistent with Fed officials' projections and market pricing. Ed Al-Hussainy, Portfolio Manager at Columbia Threadneedle Investments, said Waller is seen by the market as a "safe choice," suggesting limited room for market repricing if he were appointed. He noted that as a candidate with orthodox policy views, Waller's nomination might lead to a slight decline in long-term Treasury yields and a flatter yield curve. Kevin Hassett Nomination probability: 5%. Last Friday, U.S. Treasury yields rose and stocks pared gains after Trump signaled a preference for keeping Hassett at the White House. This reaction indicated that investors view Hassett's stance as most aligned with Trump and his desire for rate cuts. "Hassett is likely seen as the most loyal candidate, so his appointment could lead to lower short-term rates and potentially higher long-term rates," said Priya Misra, Portfolio Manager at J.P. Morgan Asset Management. However, Hassett's prospects dimmed following the political backlash in Washington after the DOJ initiated an investigation into Powell, making it more difficult for a Trump loyalist to secure Senate confirmation. Trump could, of course, still change his mind and nominate the economist. Marlborough's Athey said that if Hassett were ultimately appointed, the yield spread between U.S. 2-year and 30-year Treasuries could widen by approximately 15 basis points. "The market perceives Hassett as the candidate with the least independence," he added.
Comments