The future of Federal Reserve policy — which has served as the linchpin of the second-longest bull run in market history — hinges on a choice between conformity and change.
One side are those offering basically the same path the central bank has been on for the past decade or more, a course that includes low interest rates and a heavy hand when it comes to regulating the nation's banking system. They're represented by current Chair Janet Yellen as well as incumbent Governor Jerome "Jay" Powell and dark horse Neel Kashkari, the head of the Minneapolis Fed.
On the other side are the agents of change.
They would chart a Fed that would take its foot off the accelerator more quickly, raising rates and unwinding the $4.5 trillion balance sheet built up during the crisis-era stimulus efforts. On top of that, they would ease up on banks, and are represented most prominently by current front-runner Kevin Warsh, a former Fed governor, and longshot John Taylor, a Stanford economist known for the rate-setting rule bearing his name.
Then there's the middle road. Gary Cohn, currently President Donald Trump's chief economic advisor, probably would advocate both a more dovish approach to rates, like the status quo group, and a looser regulatory approach, like the rebels.
It will be up to Trump to make the choice, and he has indicated he will do so in the next two or three weeks.
Whichever side prevails, or whether it's yet another way that the market has not considered, will be key both for the future of monetary policy as well as the economy and how the U.S. fits into a shifting global framework.
"This is a president who doesn't go along with conventional thinking," said Brian Gardner, managing director at financial services firm Keefe, Bruyette & Woods. "There's a higher possibility of a surprise than there has been in past selections of Fed chairmen."
Still, when all is said and done Gardner thinks Trump will pick either Warsh or Yellen, though the two would seem to sit on opposite ideological ends. Gardner thinks Yellen stands a better chance than market chatter currently gives her, with the thinking being that Trump likes the combination of a hot stock market and a weak dollar.
"Sitting Fed chairs tend to get renominated by new presidents," he said. "A new president wants continuity, doesn't want to be rocking the boat, although this one clearly does like rocking the boat."
Handicapping the leaders
While Fed officials tend to hold their own ideological positions, it's rare for them to openly disagree. During Yellen's tenure, most rate decisions have passed either unanimously or with only one or two dissenters.
Bank of America Merrill Lynch, however, compiled a useful guide for where those on the inside track stand:
"We see Warsh as the most hawkish and most likely to change the way the Fed conducts monetary policy, leaning toward rules-based policy. We also think he would favor a lower ultimate size of the balance sheet but would be a strong proponent of deregulation," Michelle Meyer, U.S. economist at BofAML, said in a note.
"Powell's stance seems fairly consistent with the current framework of the Fed while Cohn would likely lean a bit more dovish and emphasize putting in place monetary policy to complement fiscal policy reform," Meyer added.
Yellen, of course, is a known quantity as a result of her 13-year history with the Fed, which she has chaired since 2014.
Under her leadership, the central bank slowly started raising rates from the near-zero crisis level, and has put into motion the balance sheet unwind. The latter operation will entail the Fed allowing some of the proceeds it gets from maturing bonds to roll off each month. While the total reduction will be small — $50 billion a month after one year — the process is significant as it marks a turn from the ultra-loose policy the Fed has followed since beginning to cut rates in 2007.
Replacing her now would be a gambit for Trump, who has been talking up the strength of the economy and stock market and has ceased the attacks he launched at Yellen during the 2016 presidential campaign. There's also the question of who Trump is taking advice from on the matter; one Fed-watcher who asked not to be named noted that the president "usually follows the last person he talked to" when making key decisions.
"As the field of realistic Fed Chair candidates has narrowed, so the changes at the Fed have increasingly become a focal point for market discussion and speculation," Alan Ruskin, macro strategist at Deutsche Bank, said in a rundown of Fed candidates and potential consequences.
In his view, Ruskin sees Warsh as a kind of dividing line.
"In terms of market impact, much of the immediate market reaction to an announcement would come from is it Warsh or not because: i) Warsh is currently the favorite and so at least marginally priced in; and ii) is seen as potentially more hawkish than the other leading candidates," he wrote. "Bear in mind the response to Yellen and Powell in particular will be partly a reversal of any expected Warsh effect."
One of the issues the market will be watching is whether the new Fed advocates a "rules-based" approach to rate policy. Essentially, that means the policymaking Federal Open Market Committee would raise or lower rates based on gauges like the unemployment rate and inflation.
Taylor would be most likely to follow that route, as he has devised just such a rule. However, the balance of the group probably would be less inclined given the vagaries that go with the modern-day economy.
Still, Ruskin thinks Warsh, combined with Randal Quarles, who was confirmed to the Fed board Thursday, and Marvin Goodfriend, an economist many believe Trump will nominate, could form a group that would at least move more closely to a rules-based structure.
"In terms of market response, Warsh and Cohn might be regarded as candidates most likely to ruffle feathers. Warsh's past comments work against the Fed making up short-term policy that 'baby-sits' financial markets," Ruskin said.
Trump being Trump, though, the final decision is hard to handicap. PredictIt, which handicaps the probable outcome of various events, has Warsh as the leader with a 47 percent chance, though Powell has come on strong lately and stands at 32 percent, with the rest of the field well behind.
WATCH: Larry Kudlow talks about how Kevin Warsh might change things at the Fed.
