Thursday, 10 October 2013

Mellow Yellen?

President Obama has nominated the first female to chair the Board of Governors of the Federal Reserve System in its history. This ought to have been a political easy win for a democratic President but the picture is more complex than it seems.

Other than demonstrating the President’s commitment to equal rights, any further political implications of the appointment (which is subject to confirmation by the Senate) would be unhealthy - the highest profile aspect of the job is chairing the Federal Open Markets Committee (FOMC) which sets monetary policy for America. This has, however, been an extremely politicised appointment and in the most unexpected of ways.  The first point to make is that Yellen was the most obvious candidate (having served as vice chair for the past three years).  She has an excellent academic background and first served the Federal Reserve System back in 1994.

The great concern about the politicisation of monetary policy is that interest rates will be too loose at the whim of the government, helping them to  be re-elected but risking inflation by doing so.  But on this score Yellen is a better candidate for the White House than most too. She is a renowned dove, very much in the mould of her soon-to-be predecessor Ben Bernanke. So much so in fact that the portmanteau Yellanke is destined to be used to describe the monetary regime that spans the current phase of Federal Reserve policy.

Nevertheless Ms Yellen is only getting the job as President Obama’s second choice - his preference was for  former economic adviser Larry Summers. Why? Not just because Mr Summers has a history of serving the Democratic Party in the White House. After all both Mr Summers and Ms Yellen also served the Clinton Presidency of the 1990s. And it’s not because Mr Summers offers the prospect of a more pro-growth policy.  Rather Mr Summers would almost certainly have tried to steer the FOMC away from the path of quantitative easing (QE).

Rather, we suspect, the President’s mind in his second term shifts from popularity (he can’t serve a third) to his legacy. We suspect President Obama wants his legacy to include successfully emerging from an era of massive unconventional monetary stimulus by ending quantitative easing.  He may have feared that Ms Yellen was the wrong woman for that particular job but his plans to have Mr Summers nominated were undone by members of his own party who disliked Mr Summers’ association with light-touch regulation.

By the same token investors believe Ms Yellen’s appointment makes it likely that QE will continue to support markets.  Despite the ‘Yellanke’ tag, however, the latest Fed minutes reinforce our suspicion that the balance between hawks and doves on the FOMC will remain extremely tight and so barring the most severe of catastrophes emanating from the current fiscal standoff there will be significant pressure to taper once more as we near the end of 2013.

Guy Foster
Head of Portfolio Strategy

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