US President Donald Trump announced his nomination of former Fed governor Kevin Warsh to replace Jerome Powell, whose term ends in May.
Warsh is one of the more hawkish picks among the perceived candidates, market participants said of the choice, for which they have been gaming out scenarios for months.
"If the nominee is indeed Warsh, we could actually end up with a Fed that tilts hawkish at the margin," Sonu Varghese, global macro strategist at Carson Group in Chicago, said on Thursday.
The other leading candidates for the role were Fed Governor Christopher Waller and BlackRock's chief bond investment manager, Rick Rieder. White House economic adviser Kevin Hassett was an early frontrunner but became an unlikely choice after Trump said he would rather keep him in his current post.
Fed interest-rate decisions impact not only the daily rate at which banks lend to each other but also long-term interest rates, as measured by long-dated US Treasury yields, which in turn influence borrowing costs for consumers and companies.
The president wants the Fed to cut interest rates deeply and has piled pressure on Powell - whom he has nicknamed "Too Late" for hesitancy in complying with Trump's wishes for looser policy.
Trump's pick will be scrutinized for his perceived ability to carry out monetary policy without ceding to political pressure, a quality that economists say is the bedrock of any central bank's inflation-fighting capabilities and what underpins the financial stability of the US economy.
Warsh at odds with Trump on monetary policy
Warsh has called for regime change at the central bank, seeking among other things, a smaller Fed balance sheet, a goal seemingly at odds with Trump's preference for looser monetary policy.
Warsh "is on record as saying he prefers lower rates," said Damien Boey, portfolio strategist at Wilson Asset Management in Sydney. "But the trade-off that he makes with lower rates is that he wants the Fed to have a smaller balance sheet. The markets are reacting as if thinking: 'What would the world look like with a smaller Fed balance sheet?'"
The dollar rose on Friday, recouping some of its week-long slide, after Trump said he would soon announce his nominee and speculation mounted over Warsh.
"The dollar does seem to be up on that news, and I think that's because... it's generally considered that Kevin Warsh is a little bit less dovish than perhaps Kevin Hassett," said Kristina Clifton, senior economist and senior currency strategist at Commonwealth Bank of Australia in Sydney.