by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EST] On Friday, Fed Governor Tarullo announced his retirement.  Although his term ran until 2020, there was growing speculation he would leave.  He has undertaken the role of lead regulator, a position that Dodd-Frank created but was never filled.  It was expected that President Trump would fill the role and, when he did, Tarullo would resign.  There are a number of names swirling around as replacements.  David Nason, who was on Sec. Paulson’s TARP team, is thought to be the front-runner.  John Allison, former head of BB&T (BBT, 46.63), and Tom Hoenig, former KC Fed president and current FDIC chair, are also being considered.  Based on our scoring, Tarullo is rated a “5,”[1] making him a hard dove.  Although we don’t know how Nason would vote, we would expect him to be a moderate, making him a “3.”  Hoenig and Allison would likely be hard hawks, or “ones.”  Tarullo’s last meeting will be the March gathering, and his leaving changes the voting average from 3.5 to 3.3.  Simply put, Tarullo’s departure from the FOMC does make it a bit more hawkish.  Potentially, President Trump could turn the board more hawkish when he fills this slot.

Interestingly enough, Scott Alvarez also announced his retirement last week from the position of general counsel of the Federal Reserve.  His guidance has been to deregulate; we would look for Yellen to replace him with someone less inclined in this direction.

In addition to Tarullo’s position, two open governor positions remain on the FOMC.  The names being floated include John Taylor (yes, that John Taylor of the “Taylor Rule”), Kevin Warsh and Glenn Hubbard.  Although Taylor appears hawkish, we suspect he would be more moderate in practice.  We would rate him as a “2,” or a moderate hawk.  Warsh’s positions are a bit less clear but we would probably rate him a “2” as well; he is less of an academic in terms of monetary policy and more of a regulatory expert.  Hubbard is probably a “3”; he is a conservative economist but well regarded and cautious.  Any two of these three would tend to move the FOMC in a more hawkish direction.

Chair Yellen begins her semi-annual report to Congress tomorrow.  If the FOMC is considering a hike at the March meeting, we would expect her to begin preparing the markets for a move.  Presently, the market only has around a 35% likelihood of a rate hike next month.

Treasury nominee Mnuchin appears likely to be confirmed this evening.  Current speculation is that he is picking mostly establishment types for important deputy and undersecretary positions, including  Jim Donovan, who was part of the Romney campaign and a former Goldman partner (GS, 242.72), and Justin Muzinich, former Morgan Stanley banker (MS, 44.70) and policy director for the Jeb Bush campaign.  David Malpass looks poised to get a role at the Treasury as well.

In the populist/establishment box score, we note a long article in the NYT over the weekend on David Cohn, who is head of the National Economic Council and former Goldman Sachs COO.  The report was favorable for Cohn, seeming to suggest he has a steadying influence.  With Mnuchin’s confirmation and his expected selections, the establishment is filling seats which should give them a bigger voice around Trump.

Finally, there are rumors swirling that Gen. Michael Flynn, current National Security Advisor, may be on his way out as it appears he may have discussed lifting sanctions on Russia after the election.  Not only is this potentially illegal, he told VP Pence he didn’t discuss sanctions and Pence relayed that report to the media.  From a market perspective, this isn’t necessarily a market mover.  However, we mention it for two reasons.  First, Flynn probably rests in the populist camp and is undoubtedly a Jacksonian.  He is particularly negative on Iran and, if he is ousted, tensions with Iran may ease somewhat.  Second, it should be remembered that President Trump ran a popular reality TV show where he fired people.  It would not be out of character for him to move quickly against someone who has lost his favor.  That could be true for the entire cabinet.

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[1] We use a “1 to 5” scale, with 1 being the most hawkish and 5 the most dovish.