Posted on 31 August 2013.
With Federal Reserve Chairman Ben Bernanke expected to retire when his term is up in early 2014, all eyes on Wall Street are on who the next Chairman of the Federal Reserve will be and how the next Chairman of The Federal Reserve will impact the stock market. The selection of a new Federal Reserve Chairman is usually something stock market participants are interested in to gauge the future direction of United States monetary policy and interest rates. This time around, interest in who is named the new Federal Reserve Chairman is particularly strong since the Federal Reserve’s quantitative easing program has been in place for years and statements by current Federal Reserve Chairman Ben Bernanke indicate that the Federal Reserve may start tapering quantitative easing during the fall of 2013. Wall Street and stock market participants are looking for clues as to how quickly quantitative easing may end and the opinions of contenders for Federal Reserve Chairman position regarding the quantitative easing program and the Federal Reserve’s high liquidity money policies.
President Obama is interviewing three candidates for the position of the Chairman of the Federal Reserve: former Treasury Secretary Larry Summers, Vice Chairwoman of the Federal Reserve Janet Yellen, and former Federal Reserve Vice Chairman Donald L. Kohn, who is considered to be the long-shot of the three candidates. It is very unlikely that the President will nominate someone other than the three leading contenders that are known to be under active consideration for the position.
All three candidates are generally expected to continue the policies put in place by outgoing Chairman Bernanke; however, they do have some differences in philosophy that may ultimately impact stock prices going forward. Larry Summers is considered the most hawkish of the three regarding monetary policy, and would likely be inclined to tighten Federal Reserve monetary policy faster than the other two candidates. Janet Yellen is considered to be an independent thinker who would likely run an even more activist Federal Reserve than Bernanke, who is considered to be the most activist Federal Reserve Chairman in history for his aggressive monetary easing policies. Donald Kohn is considered to be very dovish on Federal Reserve monetary and interest rate policies, and per his public comments would continue the Federal Reserve’s easy-money policies until forced to tighten due to “the risk of overheating and of a sustained rise in inflation above target.”
Many media reports indicate that Larry Summers is the leading candidate to be the next Chairman of the Federal Reserve, which presents a concern for investors since Mr. Summers has been critical of the Federal Reserve’s quantitative easing program and loose money policies. While nobody expects the next Federal Reserve Chairman to make dramatic changes to United States monetary policy and interest rate, with Summers at the helm of the Federal Reserve, it is quite possible that tapering could be accelerated. Additionally, normalization of interest rates to levels more consistent with the current economic environment could come sooner than the stock market has priced in.
Summers is the leading candidate to replace Ben Bernanke because President Obama has stated several times over the summer of 2013 that he does not want Federal Reserve policies to create yet another financial bubble in the United States economy. Easy money policies during the 1990s, under Federal Reserve Chairman Alan Greenspan, are generally regarded as a contributing factor in the late 1990s technology stocks bubble, while low interest rate policies implemented by Alan Greenspan after the 2001 recession are widely considered the main cause of the housing bubble that burst in 2006 and led to the financial meltdown and crisis of 2008 and 2009. If President Obama’s public statements are taken at face-value, then it appears he wants to avoid creating a new bubble in the United States economy due to prolonged quantitative easing and artificially low interest rates. In that case, Summers is the Federal Reserve Chairman that is most likely to follow this policy.
Janet Yellen has stated that she would like to primarily focus the Federal Reserve’s monetary and interest rate polices to fulfill the Federal Reserve’s mandate to provide full employment. The Federal Reserve’s other operational mandate, as set forth in Federal law, is to manage inflation in the United States economy. While Ms. Yellen’s objective to bring down the unemployment rate in the United States is a worthy goal, it would require a continuation and expansion of the Federal Reserve’s easy money polices, something that President Obama does not appear to favor.
With the choice for next Chairman of the Federal Reserve down to two leading candidates, Yellen and Summers, it is important for stock market investors to understand how the next Chairman of the Federal Reserve will impact the stock market.
Yellen will likely continue and expand the easy money polices put in place by Ben Bernanke, which will increase the liquidity in the United States economy that is partly responsible for the impressive bull market that has occurred since the stock market bottomed in March 2009. Yellen’s policies would be bullish for the stock market in the short to medium term, but will also likely lead to a stock market bubble that could end in a nasty bear market selloff, once liquidity is eventually drained and monetary policy is tightened during at some point in the future.
Summers’ policies would be less bullish for the stock market in the short to medium term, and could even lead to a bearish stock market selloff, as he is likely to reduce liquidity in the United States economy by ending the quantitative easing program more quickly than Yellen would. If Summers can manage Federal Reserve monetary and interest rate policies in such a way as to end quantitative easing without sending the United States into a recession, his policies could be quite bullish for the stock market in the medium to long term, as sustained economic growth under normalized interest rates would provide a healthy economic backdrop for company earnings to grow and stock prices to increase.
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