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Markets' next worry: Who will replace Gary Cohn?

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Markets' next worry: Who will replace Gary Cohn?

Possible replacements for Gary Cohn as director of the National Economic Council include a sharp critic of China whose appointment could deepen fears of a damaging trade war, and a CNBC commentator who would be a trusted figure in the Oval Office but might be unwilling to challenge the president.

Markets tanked on the news that Cohn is quitting, underscoring the importance of the appointment. The former Goldman Sachs banker was viewed as a bulwark against President Donald Trump's perceived predilection for upending the established economic order. The latest manifestation is the apparently imminent imposition of onerous duties on imported steel and aluminum — a move some market participants fear could touch off a global trade war.

The role of the top presidential economic adviser is particularly important, even amid continued economic growth fueled by tax cuts and deregulation. That expansion could cause inflation to rise and prompt the Federal Reserve to speed up its program of policy normalization.

If the Fed does start to move more quickly, at the same time that rising protectionism begins to hinder economic growth and depress longer-term bond yields, "there could be a risk of a flattening yield curve," said Kristina Hooper, chief global market strategist at Invesco.

"In an extreme scenario, there could be potential for an inverted yield curve," she added. Inverted yield curves are commonly viewed as harbingers of recessions.

"Fiscal policy and monetary policy are inextricably intertwined now, and with the looming explosion in entitlement spending we need people who are clear about how these interactions might (and should) get resolved," said Eric Young, professor of economics at the University of Virginia, in an email.

"For example, with rising spending but no appetite for raising taxes, eventually we will face inflationary pressures to prevent the debt from exploding," he added.

Given the complexity of the job facing Cohn's successor, investors will likely study the backgrounds and policy preferences of the potential candidates — a list first reported by Axios:

Peter Navarro: The White House trade bulldog, who, along with Commerce Secretary Wilbur Ross, is credited with advancing a harsh protectionist program. The Harvard-educated economist is a longtime professor at the University of California, Irvine, where he was best known as a "China hawk," publishing books with provocative titles like "Death by China," about the effect of free trade on American middle-class workers. He fits the bill well for Trump on trade and the President recently promoted him.

But he would bring little else to the job, other than the conviction that protectionism will cure all that ails the U.S. economy, one person with knowledge of the role said. Look for a continued market sell-off should Trump go with Navarro, one market participant warned.

Kevin Warsh: The Harvard-educated lawyer worked at Morgan Stanley before turning to government service, including a stint on the Fed's Board of Governors, and was reportedly under consideration for Fed Chairman. That background gives him credibility with both markets and politicians. Though he does not know markets the way Cohn does, he would be in the traditional Republican mold: conservative, but supportive of free trade.

"Warsh would likely push for a combination of continued deregulation, particularly of financial markets, and reductions in spending/taxes," Young noted.

"He checks so many boxes as to what markets are looking for with regards to an economic policy adviser," said another person familiar with the role's requirements.

Shahira Knight: Knight, who has an economics degree from George Mason University, is a tax policy wonk with experience on Capitol Hill. She worked as a lobbyist for Fidelity Investments and was an aide to the House Ways and Means Committee. She is also the inside candidate, serving as deputy director of the NEC. Knight's focus on taxes could be welcome, one market participant noted, because there will be a lot to be done to implement the new law.

"And, if you're Wilbur Ross, you might want someone like [Knight] appointed," this person said, "because she won't be as focused on trade."

Larry Kudlow: The CNBC commentator would be the "loyalty" candidate, according to people with knowledge of the role. He is mostly an on-air personality, but that and his strong adherence to supply-side economics have made him an informal adviser to Trump. "He'll tell you he talks to the President every day," said one person familiar with the NEC.

While Kudlow may be one of the few people to whom Trump would actually listen, he may be too loyal to confront Trump on economic policy issues.

The White House did not reply to a request for comment on potential candidates or whether an active process was underway to determine a replacement. The individual candidates could not be reached or did not respond to requests for comment.