The Boss

Same as the old boss. In the midst of partisan rancor over fiscal policy comes news on monetary policy. The appointment by the White House of Janet Yellen as the next Fed chair holds little market significance in the short run as fiscal policy concerns over the debt ceiling dominate our near-term investment outlook. Moreover, the appointment confirms what markets had anticipated, so investors should expect little market reaction in the short run.

However, it’s in the long run that today’s “news” will matter. Here are three reasons why:

1.   The monetary policy substance of a Janet Yellen-led Fed will be consistent. Likely, it will be more of the same – if not even more—of the accommodative policy as under her predecessor. The manner in which she conducts herself may well be different, but we expect the substance of that policy to much the same: as Rick Rieder recently highlighted in his blog post, “low for longer” remains the economic rationale for Fed policy. A Yellen-led Fed further reinforces such a viewpoint.

2.   The exit is the bigger issue. The longer-run importance of the choice of the next Fed chair will lie not with the continuation of its current highly accommodative policy but rather how it orchestrates an exit from such policies. It’s here where we honestly don’t have any idea as to how a Yellen-led Fed will act. We would guess neither does she. The forces that come to bear upon the Chair and the institution when it comes time to withdraw policy accommodation will be of the political not economic vein. How the Fed and its Chair responds to those pressures will be of greatest significance over the longer term.

3.   Key to the longer term: assessment of the costs of zero interest rate policy (ZIRP). Equally challenging to the next Fed chair will be a proper assessment of the long–term costs of unconventional monetary policy and persistent zero-interest-rate-policy and the consequences of the much larger Fed balance sheet built from unconventional monetary policy that she both instructed and inherits. Some in the Federal Reserve (including Governor Stein, Governor Powell, and Richmond Fed President Lacker) have warned of the potential destabilizing financial system risks of asset inflation and “reach for yield” investor behavior resulting from these programs. So it appears that in the short term, Ms. Yellen’s disavowal of the potential costs of these policies further extends the zero-interest-rate-policy expectations even farther into the future. For financial markets addicted to the easy money policies of the Bernanke-led Fed, this should be welcome news. The ultimate reconciliation of costs and benefits will be the next Chair’s legacy.

Investors’ take-away? In the short run, the punch bowl just got a new server. For more discussion, see the BlackRock Investment Institute’s “The Road Ahead for the Fed.”

 

Jeffrey Rosenberg, Managing Director, is BlackRock’s Chief Investment Strategist for Fixed Income, and a regular contributor to The Blog. You can find more of his posts here.

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