Fed leadership transition on shaky ground as clock ticks on Powell's term

By Ann Saphir

April 16 (Reuters) - The prospect of a smooth-and-on-time transition to U.S. President Donald Trump's pick for the next Federal Reserve chief, Kevin Warsh, looks increasingly to be on shaky ground, setting up a possible clash over who runs things in the meantime.

There are growing doubts that Warsh will win confirmation from the full Senate by the end of current Fed Chair Jerome Powell's leadership term on May 15, even as the Senate Banking Committee is set to proceed next Tuesday with a hearing on the nomination.

The storm clouds have gathered over Warsh's confirmation largely as a result of opposition from Republican Senator Thom Tillis, who has vowed to block the process until the Department of Justice ends an investigation of Powell's oversight of renovations to the Fed's headquarters in Washington, D.C.

And while?Republican Senator Tim Scott, who chairs the banking committee, says he is confident the DOJ will wrap up its probe in the next "several weeks," there's no sign of an off-ramp. Trump said he wants to see the investigation through, even after a federal judge this month quashed the government's subpoenas as no more than a pretext for putting pressure on Powell to lower interest rates, as the president wishes.

U.S. Attorney for the District of Columbia Jeanine Pirro, a close ally of Trump, has promised to appeal the judge's decision, and on Tuesday two government prosecutors and an investigator visited the Fed's renovation job site and asked to tour it, but were turned away.

The incident drew an emailed rebuke from a Fed lawyer and a tweet from Tillis with a photo of the notoriously hapless "Three Stooges" comedy troupe.

WHAT HAPPENS AFTER MAY 15?

If Warsh is not confirmed by May 15, Powell has said he will serve as the "pro tem" chair of the Fed's seven-member Board of Governors, because "that is what the law calls for" and that is what the central bank has done previously.

Trump said on Wednesday that he would fire Powell if he stayed on. Such a move would be unprecedented and would surely invite a legal challenge, as did the president's attempt last summer to fire Fed Governor Lisa Cook.

That case is pending at the U.S. Supreme Court, and Cook remains in her job.

The White House also could try to appoint another Fed governor - perhaps Stephen Miran, Trump's former economic advisor - in Powell's place, analysts said.

Whether such a move would hold up in the courts is not clear.

In 1978, President Jimmy Carter avoided a gap in the Fed leadership when he appointed Arthur Burns to remain as acting Fed chief while Carter's pick for the top job was going through the confirmation process.

But that move occurred before the law changed to require Senate approval of a president's Fed chief pick. Another piece of legislation enacted since then - the Federal Vacancies Reform Act of 1998 - bars the president from designating an acting officer to run a multi-member board at agencies.

"On the White House side, it's their choice whether or not to challenge it," said Derek Tang, an analyst with forecasting firm LH Meyer. "If the White House does go after the nuclear option and start suing and challenging things, then it might shake the (market's) confidence in the Fed," though he added that markets so far seem unfazed by the potential drama ahead.

TRICKY TIMING

With high oil prices from the Iran war pushing up inflation and squeezing family budgets, the Fed is seen as unlikely to deliver a rate cut anytime soon.

"Political pressure on the central bank at a time of an energy price shock is not risk-free, even if it ultimately goes nowhere," Evercore ISI Vice Chairman Krishna Guha said. "It increases - at least at the margin - the risk inflation expectations could rise on fears the Fed will not be able to do whatever is required to return inflation to target in the medium term."

At next week's Senate banking panel hearing, Warsh is likely to face a friendly Republican majority and hostile questioning from Democratic lawmakers who worry that confirming Trump's pick for the job will imperil the central bank's independence.

"The White House remains focused on working with the Senate to swiftly confirm Kevin Warsh as the next chairman of the Federal Reserve," White House spokesman Kush Desai said.

Tillis' opposition aside, the timing is tight. The Senate has squeezed a Fed nominee through from hearing to confirmation in less than a month only once, and that was just for a regular Fed governor, not for the leader of the world's most important central bank.

Trump administration officials have expressed confidence that Warsh will be confirmed in time.

It may be a case of "be careful what you wish for."

"In the next few months, the reality on the ground is inflation is going to be really high," LH Meyer's Tang said. "Do you really want one of your guys in place to be the fall guy for keeping rates high?"

(Reporting by Ann Saphir, Jacob Bogage, Howard Schneider and Michael S. Derby; Editing by Dan Burns and Paul Simao)