Bond yields jump on report former Fed official Kevin Warsh met with President Trump

Treasury yields rose suddenly on reports that Kevin Warsh, a former Fed governor, met with President Donald Trump Thursday to discuss his potential nomination as Fed chair.

Warsh has increasingly been seen as a leading candidate to replace Fed Chair Janet Yellen and bond traders view him as a hawkish choice. The PredictIt probability market gave him odds of over 40 percent, well ahead of Yellen.

The 2-year note yield edged slightly higher to 1.4787 percent after the report from the Wall Street Journal. CNBC later confirmed the meeting took place. The 10-year yield rose to 2.32 percent.

“The key factor that the market is focusing on is he would less accommodative than Yellen has been as a baseline in terms of QE [quantitative easing], the path of tapering and the potential path of rate hikes. All of that should be reconsidered if Warsh is a serious candidate and it sounds like he is,” said Aaron Kohli, director fixed income strategy at BMO.

Administration officials have said that Yellen and others were under consideration for the chairmanship. Yellen’s term ends in February, and Trump has made favorable comments about her.

However, analysts note that Yellen is very vocal about the Fed’s regulation of the financial industry and Trump would like to see some regulation loosened. Warsh, who has a Wall Street and government background, would be seen as someone who would be more interested in deregulation. His father-in-law, Ronald Lauer is also a close associate of Trump.

But the dilemma for Trump, who has said he likes low interest rates, is that the candidates who are more likely to push more lax regulation are those that might move faster to normalize rates.

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“It becomes muddier because most people that sit in that seat have to moderate their views based on reality, and the reality is that inflation isn’t moving,” said Kohli. “As much as we believe he would taper aggressively, and raise rates aggressively, it might not come to that.”

Kohli said the long end of the curve may not see rates rise that much if Warsh is a serious contneder because the market would view a quicker move to reduce the Fed’s balance sheet, through tapering bond purchases, or to raise interest rates could slow economic growth.