There will always be a "storm from the clear sky" in history! Should U.S. stocks beware of the Federal Reserve's "change of leadership curse"?

The Federal Reserve is set to undergo a highly anticipated leadership change this year—former Federal Reserve Board member Kevin Wash has been nominated by U.S. President Trump to become the next Fed Chair, with a potential handover from Powell as early as May this year.

Based on past experiences of Fed leadership transitions, this could inject new volatility into the U.S. stock market…

Data compiled by Alexander Altmann, Head of Global Equity Tactical Strategy at Barclays Bank, shows that since 1930, within one, three, and six months after a new Fed Chair takes office, the average maximum drawdowns of the S&P 500 have been 5%, 12%, and 16%. These declines have all exceeded the typical peak-to-trough drops within any randomly selected year for the S&P 500.

In a report to clients, Altmann wrote, “While the market may be anxious about whether Mr. Wash is perceived as ‘hawkish,’ the real test is more likely to come after May. New Fed Chairs typically face some degree of ‘test’ from the stock market within the first six months of taking office.”

In fact, reviewing the experiences of the past five Fed Chairs during their first half-year in office, similar ‘leadership change curses’ are not without reason. Aside from Yellen’s initial period, the S&P 500 experienced at least short-term ‘storms’ after four other Fed leadership changes.

For example, during Powell’s first week in February 2018, the U.S. market suffered a sharp decline. At that time, rising inflation expectations triggered a ‘Volmageddon,’ causing stock indices to plummet rapidly.

The turbulence during Bernanke’s tenure occurred around his fourth month in office. In May-June 2006, concerns over excessive rate hikes by the Fed led to a significant sell-off.

Greenspan’s misfortune was even more severe—just three months into his tenure, the market faced the ‘Black Monday’ crash of 1987, with the S&P 500 collapsing in a very short period.

Additionally, to combat runaway inflation, Volcker aggressively raised interest rates right after taking office in August 1979, leading to intense market turmoil in the fall of 1979.

Could Wash also be headed for a similar ordeal?

These historical experiences have undoubtedly kept many Wall Street traders on edge this year, the ‘Fed leadership change year.’

Moreover, unlike previous transitions where the ‘old rules’ seemed to persist (from Greenspan to Bernanke to Yellen to Powell, with monetary policy almost a seamless continuation), this time, Wash, who was chosen by Trump, carries the label of ‘big reform, big overhaul’ of the Fed.

If confirmed by the Senate, Wash will face a market tense over Trump’s multiple criticisms of Powell’s perceived insufficient easing—markets are already worried about the Fed’s independence.

Furthermore, after President Trump’s nomination of Wash to succeed Jerome Powell was announced last Friday, U.S. stocks fell sharply, and gold and silver prices experienced a historic crash, as traders viewed Wash as the least dovish among the main candidates for Fed Chair. Wash previously served as a Fed Board member from 2006 to 2011.

During his previous tenure at the Fed, Wash was known for his hawkish stance. Although he has publicly advocated for rate cuts in recent years to align with the President’s views, his support for balance sheet reduction remains a major market concern. Over the years, Wash has repeatedly criticized Fed officials for allowing the central bank’s assets to balloon, fueling speculation that he might swiftly pursue balance sheet reduction if he takes office.

Many industry insiders believe that this leadership change at the Fed could intensify the uncertainty surrounding monetary policy—current policies are already under pressure from signals of high inflation and cyclical cooling in the employment market.

Christopher Harvey, Head of Capital Markets Equity and Portfolio Strategy at Canadian Imperial Bank of Commerce, pointed out that if the Fed begins to shrink its balance sheet—this move would withdraw liquidity from the financial system and could negatively impact risk assets.

On the other hand, Morgan Stanley strategist Michael Wilson wrote in a client letter on Monday that Wash’s reputation as a hawk on the balance sheet might help curb gold prices and moderately support the dollar, thereby “buying time for the broader policy implementation as planned.”