How investors are preparing for a new Fed

Markets have been calm despite worries about a less independent, more divided central bank

- Sam Goldfarb

Analysts warn that a less independent Fed would pose a major threat to the economy and markets.

(BLOOMBERG)

Investors are preparing for a very different Federal Reserve in the year ahead.

President Trump has signaled that he is closing in on a pick to be the next central-bank chair. He has also doubled down on his demand for lower interest rates and recently told The Wall Street Journal that he expects the new leader to be on board with his agenda.

So far, markets have shown few signs of significant concern that the Fed would completely surrender its independence. But investors are still bracing for a central bank marked by unusual division, a potentially weaker chair and the lingering threat of more radical change.

Here is a look at how they are assessing the different paths that the Fed could take:

Analysts warn that a less independent Fed would pose a major threat to the economy and markets.

Although the Fed controls short-term interest rates, borrowing costs in the U.S. are heavily influenced by yields on longer-term U.S. government bonds. And those are determined by investors’ expectations for short-term rates in the future, rather than where they are now.

If the central bank cuts rates aggressively when the economy is still in decent shape, worries about inflation and higher rates could drive yields and borrowing costs up rather than down. A sharp climb in yields could also rattle stocks.

Moves have been muted so far. One reason: Fed chairs have historically wielded outsize influence over the 12-person Federal Open Market Committee that votes on interest rates, but they don’t have the power to set rates on their own. So a lot would be required for Trump to gain clear control over the central bank.