Can a ‘Shadow Chair’ Steer the Fed?

Summary

Podcast Summary: "Can a ‘Shadow Chair’ Steer the Fed?"

Thoughts on the Market
Host: Seth Carpenter, Morgan Stanley's Global Chief Economist
Episode Release Date: July 21, 2025

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Introduction

In this insightful episode of Thoughts on the Market, Seth Carpenter delves into the intriguing concept of a "shadow Fed Chair" and its potential influence on the Federal Reserve's future policies. As Jerome Powell's term as Fed Chair approaches its conclusion in May of the following year, speculation mounts regarding his successor and the possible shifts in monetary policy.

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The Succession of Jerome Powell

Duration: [00:00 - 02:30]

Seth Carpenter begins by setting the stage, highlighting the upcoming expiration of Jerome Powell's tenure as the Federal Reserve Chair in May next year. The conversation underscores the critical nature of this transition, especially given the public and political scrutiny surrounding Powell's monetary policies.

• Political Pressure: President Trump's overt criticism of Powell's policies, particularly his stance on interest rates, has intensified the debate. Carpenter notes, "President Trump has been clear in his messaging he wants the Fed to cut rates more aggressively" ([01:15]).

• Market Predictions vs. Morgan Stanley's Outlook: While market projections estimate the policy rate to hover just above 3% by the end of the next year—a reduction from the current 4.25% to 4.5%—Morgan Stanley anticipates an even lower rate. This divergence raises questions about the underlying factors influencing these differing forecasts.

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Uncertainty Surrounding the Next Fed Chair

Duration: [02:31 - 03:45]

Carpenter addresses the ambiguity surrounding the appointment of Powell's successor. Despite various media speculations and the initiation of the selection process by the Treasury Secretary, no definitive candidate has emerged.

• Selection Timeline: News outlets predict that a name will be announced by late summer, but until then, the identity of the next Fed Chair remains uncertain.

• Committee Dynamics: Emphasizing the Federal Open Market Committee's (FOMC) collective decision-making process, Carpenter explains, "The FOMC makes policy and that policy-making is a group effort. And that group dynamic tends to restrain sudden shifts in policy" ([02:50]). This collective approach suggests that immediate policy changes post-Powell may be unlikely, maintaining stability in the near term.

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The Concept of a Shadow Chair

Duration: [03:46 - 05:30]

Exploring the notion of a "shadow chair," Carpenter theorizes that even before the official appointment of a new Fed Chair, a successor could occupy a vacant seat on the Fed board starting January. This individual, while not the official chair, could exert significant influence within the FOMC.

• Influence on Policy: A shadow chair, especially if vocally different from Powell, might signal a shift in policy direction. However, Carpenter cautions that the same committee dynamics may limit immediate changes, even with an influential insider present.

• Historical Precedent: He references past instances where political appointees have adapted to the Fed's dual mandate—focusing on maximum sustainable employment and price stability—once in office. This historical context suggests that initial signals from a shadow chair may stabilize over time.

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Alternative Scenarios and Institutional Norms

Duration: [05:31 - 07:00]

Carpenter engages in a thought experiment, pondering scenarios where the FOMC could diverge from traditional practices, such as selecting someone other than the Board Chair to lead the FOMC.

• Institutional Orthodoxy: He argues that the Fed values continuity and orthodoxy, making deviations from established norms unlikely. Despite the theoretical flexibility, "I think that's unlikely in my experience" ([06:15]).

• Role of the Fed Chair: The chair's role is pivotal—not only in voting but also in setting the tone and guiding consensus within the committee. As new members join the board, the chair’s influence is poised to grow, ensuring that policy direction remains consistent.

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Implications for Investors and Market Stability

Duration: [07:01 - 08:30]

Concluding his analysis, Carpenter provides insights into what the shadow chair debate means for investors and the broader market.

• Primary Narrative vs. Nuances: Currently, the shadow chair concept adds nuance rather than dominating the narrative around Fed policy. He asserts, "We don't expect the Fed's reaction function to change between now and maybe." ([07:45]).

• Future Outlook: As the timeline extends beyond mid-next year, the range of potential outcomes broadens. However, the primary risk to Morgan Stanley's Fed forecast remains political influences rather than internal policy shifts.

• Cautious Forecasting: Emphasizing humility in economic forecasting, Carpenter acknowledges the inherent uncertainties, especially those stemming from political dynamics that could sway monetary policy.

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Conclusion

Seth Carpenter wraps up by reiterating the importance of monitoring political developments as the most significant risk factor to Fed policy forecasts. While the idea of a shadow chair introduces an interesting dynamic, institutional norms and committee-driven decision-making are likely to sustain policy stability in the foreseeable future.

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Notable Quotes:

• "President Trump has been clear in his messaging he wants the Fed to cut rates more aggressively." — Seth Carpenter ([01:15])

• "The FOMC makes policy and that policy-making is a group effort. And that group dynamic tends to restrain sudden shifts in policy." — Seth Carpenter ([02:50])

• "I think that's unlikely in my experience." — Seth Carpenter ([06:15])

• "We don't expect the Fed's reaction function to change between now and maybe." — Seth Carpenter ([07:45])

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This episode offers a comprehensive exploration of the potential shifts within the Federal Reserve's leadership and the consequent implications for monetary policy and market dynamics. Seth Carpenter's thorough analysis provides investors and market watchers with a nuanced understanding of the possible futures underpinning Fed's policy directions.

Transcript

[A]

Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's global chief economist. And today, well, there's a topic that's stirring up a lot of speculation on Wall street and in Washington. It's this idea of a shadow Fed Chair. It's Monday, July 21st at 2pm in New York. Let's start with the basics. Fed Chair Jerome Powell's term expires in May of next year. And look at any newspaper that covers the economy or markets, and you will see that President Trump has been critical of monetary policy under Chair Powell. Those facts have led to a flurry of questions. Who might succeed Chair Powell? When will we know? And maybe most importantly, how should investors think about these implications? President Trump has been clear in his messaging he wants the Fed to cut rates more aggressively. But even though it seems clear that there will be a new chair in June of next year, market pricing suggests a policy rate of just above 3% by the end of next year. That level is lower than the current fed rate of four and a quarter to 4.5, but not aggressively so. In fact, Morgan Stanley's base case is that the policy rate is going to be even a bit lower than market pricing suggests. So why this disconnect? First, although there are several names that have been floated by media sources, and the Secretary of the treasury has said that a process to select the next chair has begun, we really just don't know who Powell's successor would be. News reports suggest we will get a name by late summer, though. Another key point from my perspective is even when Powell's term as chair ends the Fed's reaction function, which is to say, how the Fed reacts to incoming economic data. Well, it's probably not going to change overnight. The Federal Open Market Committee or the FOMC makes policy and that policymaking is a group effort. And that group dynamic tends to restrain sudden shifts in policy. So even after Powell steps, this internal dynamic could keep policy on a fairly steady course for a while. But some changes are surely coming. First, there's a vacancy on the Fed board in January, and that seat could easily go to Powell's successor before the chair position officially changes. In other words, we might see what people are calling a shadow chair sitting on the fomc, influencing policy from the inside. Would that matter to markets? Possibly, especially if the successor is particularly vocal and signals a markedly different stance in policy. But again, the same committee dynamics that should keep policy steady so far might limit any other immediate shifts, even with an insider talking. As importantly, history suggests that political appointees often shed their past affiliations once they take office, focusing instead on the Fed's dual mandate, maximum sustainable employment and stable prices. But there are always quirky twists to most stories. Powell's seat on the board doesn't actually expire when his term as chair ends. Technically, he could stay on as a regular board member, just like Michael Barr did after stepping down as the Vice Chair for Supervision. Now, Powell hasn't commented on all of this, so for now, it's just a thought experiment. But here's another thought experiment. The FOMC is technically a separate agency from the Board of Governors. Now, by tradition, the Chair of the Board is picked up the FOMC to be chair of the fomc. But that's not required by law in one version of the world. In theory, the committee could choose someone else. Would that happen? Well, I think that's unlikely in my experience. The Fed is an institution that has valued orthodoxy and continuity, but it's just a reminder that rules aren't always quite as rigid as they seem. And regardless, the chair of the Fed always matters. While the FOMC votes on policy, the chair sets the tone, frames the debate, and often guides where consensus ends up. And over time, as new appointees join the board, the new chair's influence will only grow. Even the selection of Reserve bank presidents is subject to a board veto, and that would give the chair indirect sway over the entire fomc. So where does all of this leave us? For now, this shadow chair debate is more of a nuance than the primary narrative. We don't expect the Fed's reaction function to change between now and maybe. But beyond that, the range of outcomes starts to widen more and more and more. Until then, I would say the bigger risk to our Fed forecast is in politics. It's our forecast for the economy, and on that front we remain, as always, very humble. Well, thanks for listening and if you enjoy this show, please leave us a review wherever you listen and share thoughts on the market with a friend or a colleague today.

[B]

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