Will the Federal Reserve Crash the Stock Market? 3 Reasons to Watch Trump's Nominee, Kevin Warsh, on May 15

If one thing is consistent about the Trump administration, it is its unpredictability. After years of criticizing the current Federal Reserve chairman, Jerome Powell, for his arguably restrictive monetary policy, President Donald Trump has nominated someone who might be more hawkish than his predecessor. Let's dig deeper into Kevin Warsh's track record and past remarks to decide how his term might affect stock performance.

1. Warsh is aggressive on inflation

Although the Federal Reserve is independent of the White House, the president can influence its policy orientation by nominating its chairman every four years, subject to Senate confirmation. Trump nominated the current Fed chair, Jerome Powell, in 2017 (he was reappointed by Biden in 2021). And Trump has nominated his successor, Kevin Warsh, with Senate confirmation widely expected on May 15.

Image source: Getty Images.

Warsh formerly worked as a Federal Reserve governor during the financial crisis, and his track record could give investors clues about his economic philosophy and where he could take the institution.

CBS reports that from 2006 to 2011, Warsh took a hawkish stance on monetary policy, which generally prioritizes keeping inflation low, though higher rates and a smaller Fed balance sheet (liquidity added to the system through the purchase of bonds and other assets).

The Fed currently has $6.7 trillion in assets on its balance sheet. And a reduction in these holdings could hurt economic growth and stock performance by tightening financial conditions and removing liquidity from the market.

Warsh has not indicated how small he thinks the Fed's balance sheet should be. But The New York Times reporting suggests he is committed to significant reductions, seeing this strategy as a good way to give officials space to lower short-term interest rates.

2. Warsh is bullish about artificial intelligence

Perhaps the most interesting thing about Warsh is his take on generative artificial intelligence (AI). Despite his track record as a monetary policy hawk, he has recently begun invoking the new technology to justify lower rates.

The logic goes that AI will boost productivity, making it easier for the economy to produce goods and services and thus lowering their costs. It sounds good in theory, but there are some problems with the assumption.

For starters, there is no conclusive proof that generative AI will transform the global economy in the near term. The technology remains speculative, and it could even be inflationary in some cases because data center construction has caused a surge in energy costs and demand for memory chips, which are used in consumer electronics.

Furthermore, there are many other catalysts for inflation to rise in the near term, such as the Trump administration's erratic trade policy and the recent war in Iran, which has already led to a surge in gasoline prices. Investors should get nervous if Warsh uses a potential future AI boom to gloss over what the economy needs right now.

3. We can't predict this administration

Warsh's track record as a Fed governor suggests a hawkish approach to monetary policy, which could hurt stock performance in the near term. But over the long term, it might be a good outcome because it would run contrary to the White House's political goals of juicing growth and making government debt more manageable in the short term.

Such a policy would also reestablish the organization's credibility and bolster the foundations of the U.S. financial system.

The worst-case scenario is that Warsh is a Trojan horse for the White House, willing to introduce the aggressively lax monetary policies Trump unsuccessfully pressured Jerome Powell to adopt. This would not be the administration's first act of misdirection. And the perception that the Fed is losing its independence could hurt a variety of asset classes. Investors may be in a lose-lose situation.

The Motley Fool has a disclosure policy.