Larry Summers has withdrawn from the race for chairman of the U.S. Federal Reserve, and investors are loving it: Equity and bond markets have rallied in early trading on Monday, reflecting a perceived shift in Fed policy expectations. But the market could be getting ahead of itself here.
Right now, the Fed is buying $85-billion (U.S.) worth of Treasury bonds and mortgage-backed securities each month, using a program known as quantitative easing or QE, in an effort to stimulate the economy. Certainly, the stock market has benefited tremendously from QE – but the Fed has signalled that this stimulus will be wound down, and many observers believe it will announce the start of tapering this week.
However, investors are keeping a close watch not only on the current Fed leadership, but the person likely to take over from chairman Ben Bernanke in early 2014, when his term expires. Mr. Summers has questioned the effectiveness of QE, so markets had believed that he would wind down the stimulus program faster if he had been appointed Fed chairman. With someone else at the top – possibly the current Fed vice-chair Janet Yellen – stimulus could be wound down at a slower pace, or so people believe.
Here are some reactions to the news. And as you can see, QE tapering is likely to arrive – even without Summers.
Stocks: The S&P 500 jumped 0.9 per cent, touching its highest level in more than a month and coming close to a record high. But the rally wasn't confined to the United States: European blue chip stocks rose 0.8 per cent and Canada's S&P/TSX composite index rose 0.7 per cent.
Bonds: The yield on the 10-year U.S. Treasury bond fell 8.3 basis points, to 2.8 per cent, its lowest level in more than a month. The bond yield had risen as high as 3 per cent recently, raising concerns about the impact on consumer borrowing.
Tim Duy, University of Oregon: "The market reaction stems from the belief that Summers is a hawk and Yellen is a dove. While I understand that this is a widely held belief, I think it is insulting to both candidates to paint them with such broad strokes. I think that either candidate would be hawkish or dovish as the situation required. I also think that if you believe Yellen is an unabashed dove, you are going to be surprised by her reaction if inflation rears its head in the slightest."
Capital Economics: "[We] do not think that the Fed's policy stance is likely to change significantly as a result of a new Chair being elected, whoever is appointed. We're not convinced that Yellen, if she is selected, will take a much more dovish approach than Summers might have done."
Brad DeLong, University of California, Berkeley: "The Federal Reserve needs a regime shift – like the ones that Takahashi and Chamberlain imposed on Japan and Germany in 1931, like the one that FDR imposed on the United States right now, like the one that Abe is currently imposing on Japan. There are candidates off the short list who would push immediately for such a regime shift – cough, Christina Romer, cough. And my fear right now is that Janet Yellen has wrongly prejudged the issue of whether a Federal Reserve regime shift is needed right now, and will not revisit the issue de novo next year when I think the odds will be 80 per cent that a regime shift will still be desirable."
Paul Krugman, New York Times: "No profound thoughts here, except that it's really, really hard to see how Obama can justify not picking Janet Yellen at this point. Nobody else is as qualified; any other choice would look like spite."
Ezra Klein, Washington Post: "Yellen... is a consensus pick. She's Wall Street's favorite. She the monetary policy world's favorite. She's favored by congressional Democrats and organized labor. So far as anybody knows, she has nearly no enemies – at least outside the White House."
David Berman