The changing of the guard atop the U.S. Federal Reserve Board could pose some problems for financial markets suggests Morgan Stanley chief economist Stephen Roach in a new research note.

Alan Greenspan is to step down from the Fed on January 31, 2006. “Akin to the election of a new pope, the changing of the guard at the Fed is a rare and important event for the US and world financial system. In the past 27 years, it has happened only three times,” reports Roach. “In each of those instances, the transition did not go well — financial markets quickly seized up, eager to test the mettle of the new central banker.”

“My suspicion is that the curse of the Fed transition is likely to be in play again — with potentially profound implications for increasingly vulnerable financial markets,” he suggests.

Roach says that the changing of the guard simply brings uncertainty, and that tends to hurt confidence. “Saddled with a record current account deficit, the US is more dependent than ever on the confidence of foreign investors to fund ongoing economic growth,” he points out. “Moreover, in a post-Katrina, energy-shocked climate, there is good reason to expect additional reductions in personal and government saving in the months ahead… As a result, already-depressed national saving should move even lower, prompting further deterioration in America’s already massive current account deficit. In other words, America’s dependence on the ‘kindness of strangers’ is likely to increase significantly at precisely the point of an historically-delicate transition to a new a new Fed chairman,” he says.

The fact that this is a presidential appointment is also cause for concern, Roach notes. “Generalizing on the basis of George W. Bush’s most recent senior appointments, I suspect the President will look for three key traits in a new Fed chairman — familiarity, loyalty, and a pro-growth bias,” he says. “This could well pose a serious problem for US financial markets. With America’s external financing critically dependent on the foreign confidence factor, any doubts over central bank independence will not go over well.”

“With the Greenspan factor about to be taken out of the confidence equation, any fears of an ‘easy money’ Fed could well prompt foreign investors to exact concessions in those financing terms in the form of a weaker dollar and higher real interest rates,” Roach warns.

“The rocky financial market history of recent Fed chairmen transitions is a warning, in and of itself. America’s heightened vulnerability to the foreign confidence factor amplifies those risks. And President Bush’s appointment record points to a candidate who could seriously compound the perception problem. This is potentially a very tough combination. It leads me to believe that the curse of the Fed transition is about to strike again,” he concludes.