Apart from a few inflation-hawks on the United States Federal Reserve's Open Market Committee, outgoing Fed chairman Ben Bernanke has enjoyed sturdy support for his dovish-leaning decisions. This is the group that voted against tapering the rate of the Fed's stimulus operations – even when the world was betting on it – back in September, and that has supported U.S. markets through their best stock performance in a decade.
But while Janet Yellen's ascension to the chairman role at the end of January is not expected to ruffle many feathers, the start of 2014 will bring a change in the regional Fed members who vote on monetary policy – and the fresh mix of policymakers is a decidedly more hawkish bunch.
Though Mr. Bernanke's Fed was open to debate, and tolerant of a friendly cacophony on the voting committee, a glance back at 2013's rotation reveals just how dovish the FOMC was. St. Louis Fed chairman James Bullard, touted as "the voice of the Fed," usually strikes a moderate tone. Chicago Fed president Charles Evans and Boston Fed president Eric Rosengren, both super-doves, were counterbalanced only by Kansas City Fed president Esther George, the lone voting hawk. Ms. George did her best to sway policy, dissenting at seven out of eight FOMC meetings, but she was clearly outnumbered.
The coming year's voting lineup includes the Philadelphia Fed's Charles Plosser and Richard Fisher of the Dallas Fed, both of whom are counted among the group's staunchest hawks . Mr. Fisher recently announced that he was pushing for a $20-billion (U.S.) taper, instead of the $10-billion reduction announced Dec. 18. Mr. Plosser – a long-time critic of quantitative easing – has called for the Fed to focus solely on inflation, eliminating the dual mandate of price stability and jobs. There will also be three vacancies on the Board of Governors, and Cleveland Fed president Sandra Pianalto says she will retire "early next year."
So how will this shuffle pan out in the finance world?
Markets took the December taper announcement in stride, finishing 2013 with a buoyant Santa Claus rally. It's clear that tapering is not nearly as rattling to stocks as it once was, and traders and economists alike are betting that the American recovery is finally gaining solid footing.
Enduring gains next year will depend on two variables: whether U.S. economic data continues to show strength, particularly in the jobs reports and manufacturing numbers; and whether the Fed keeps short-term interest rates low for the foreseeable future. The first remains as unpredictable as ever, but while the second was thought to be inevitable – the Fed has essentially guaranteed that it won't raise rates until 2015 – one influential group is suggesting otherwise. Traders have sold three-month Eurodollar futures heavily since the Fed's tapering announcement. Money market yields now show an expected rate hike in mid-2014, which is well ahead of the Fed's published rate projections.
The market is essentially calling the Fed's bluff, and pricing in a rate hike sooner rather than later. A good deal of this price movement is a direct result of improving data, as traders will inevitably sell bonds as the macro picture brightens. Ten-year U.S. Treasury yields are likewise on the rise – from 2.89 per cent before the taper announcement, to 2.99 per cent today.
Perhaps markets are also expecting that, with the coming personnel changes, the Fed will be less inclined towards easy monetary policy next year. Some economists argue that after the Fed decided to wind down QE, the market lost faith in forward guidance.
Mr. Bernanke's Fed might have used alternative stimulus measures to combat the run-up in short-term rates.
But Janet Yellen's Fed will be far more hesitant to introduce any new easing measures, and so markets may continue testing the Fed, which means we are in for a bumpy ride next year.