The Fed at a Crossroads

August 2025

The fight to choose the next Federal Reserve Chair could be the most consequential since Paul Volcker’s appointment in 1979. After months of speculation, markets now face the real prospect that the Fed’s independence could be reshaped.

The field has narrowed to three contenders: Fed Governor Chris Waller, the continuity choice; Kevin Hassett, whose close political ties raise the most independence concerns; and former Fed Governor Kevin Warsh, the wildcard who could mark the sharpest break from recent policy.

With equities at record highs and bond markets steady, investors are in “wait-and-see” mode. But the outcome could shape markets for years to come.

A Fed Under Attack

For months, Jerome Powell has endured jibes and barbs from the President as he has swatted away suggestions for lower rates. The ghost of Arthur Burns still lingers. Investors remember how he was cajoled and manipulated by Nixon into easier policy, contributing to the Great Inflation.

The timing of this appointment raises the stakes. It comes at a time when a rare coalition of ideological opposites — from easy-money advocates to those seeking a fundamental rethink of the Fed’s role — are calling for change.

The list of shortcomings against the Fed reads like a failing end-of-term report card.

Chief amongst them is the 2021 policy error, when the Fed was slow to raise rates in response to seemingly “transitory inflation.” Warsh describes it as the greatest error in macro forecasting in 45 years.

The Fed’s overall policy framework is a second. The Fed emphasises the labour market as a driver of inflation. But that framework ignores factors such as government spending and monetary growth, both of which contributed to the 2021 inflation spike.

Quantitative easing (QE) is another bone of contention. Yes, it helped stabilise markets during the Global Financial Crisis, but extensive QE in the last decade may have distorted capital markets, fuelled inequality, and created other unforeseen consequences. Unwinding it has also been difficult.

In 2019, after a decade of low inflation the Fed changed tack to allow periods of above average inflation (what it called Flexible Average Inflation Targeting). The change arguably also contributed to the slow response to inflation in 2021.

The Fed could reasonably argue that much of the criticism is unfair. Yes, inflation remains above target, but it has fallen sharply from its 2021–2022 peak. The economy is slowing, yet unemployment is still just 4.2%. Before tariffs entered the picture, the Fed appeared to have pulled off the elusive soft landing.

Continuity or Regime Change?

Despite the Fed’s perceived failings, it is an incumbent Fed Governor who is the current favourite.

Yes, he is currently aligned with the President on the need for lower interest rates, but he is by no means a dove. He argued for higher rates in late 2021 and for faster, more aggressive tightening in 2022.

He was also correct in anticipating that inflation would fall in 2023 without a rise in unemployment – a view that put him at odds with other prominent economists at the time.

But the big question from Trump’s perspective is: how loyal will he be? Certainly, there is nothing in his approach to say that he will be a pushover on rates. If appointed, he would ease a lot of investor concern about Fed independence.

Hassett is Trump’s safe bet — and the market’s nightmare pick.

His loyalty to Trump is undeniable. He was Chairman of the Council of Economic Advisors in Trump 1.0 and after that worked for Trump’s son-in-law Jared Kushner in his private equity firm. These days, he appears almost daily on CNBC defending the President’s policies.

The clear suspicion is that he would be open to the President’s persuasions on rates, and, if appointed, the US dollar and US bonds would likely take a hit.

Warsh is the dark horse.

Like the others, he shares the President’s public criticism of the Fed and sees a case for rate cuts. But beyond the near term, a Warsh-led Fed could break sharply with the past.

He has called for new approaches, fresher ideas, and sharper debate. He opposes the routine use of QE, wants a smaller balance sheet, and accuses the Fed of enabling Washington’s fiscal profligacy through bond buying.

If his stance on QE and deficits holds, markets could face a central bank less willing to finance large fiscal gaps and less inclined to backstop markets. That combination could be far less friendly to both bonds and equities.

A Fork in the Road

Some dismiss the importance of the appointment as overblown — after all, the Chair is just one vote on the FOMC. But that ignores the Chair’s power to set the agenda, steer debate, and direct the Fed’s research. History shows that the Chair has always shaped the institution.

The Fed is already battling a crisis of confidence. More broadly, trust in US institutions is eroding, as shown by April’s rare simultaneous sell-off in stocks, bonds, and the dollar.

If America’s independent central bank is seen as compromised, it won’t just be a blow to the Fed — it will strike at the heart of the US exceptionalism narrative and global faith in the dollar and American assets.

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