Yellen vs Summers

In recent weeks much has been written and said about who President Obama should select as the next Fed Chairman. Supporters of Larry Summers and Janet Yellen are said to be each pressing the case for their candidate from behind the scenes. For a position that is supposed to float above politics, it is surprisingly political.

So without regurgitating what’s already been said, let me offer a couple of observations. Larry Summers is routinely praised for his intellect. CNBC this morning described him as a “brilliant economist”, a breathless term that many might regard as an oxymoron or at least not wholly complimentary. Although I’ve never met Larry Summers, his high IQ is so often cited by others that one is left with the uneasy feeling that he uses every interaction with people to make sure his brilliance is on display and not missed. Modesty is an adjective rarely in the same zip code as Mr. Summers. That may not disqualify him, since politics and business are both full of people unburdened by much self doubt. Nonetheless, the future is generally uncertain and the next captain of monetary policy might be expected to retain some humility with respect to the brilliance of their own views.

Janet Yellen’s qualifications are that she’s already Vice Chair of the Fed’s Board of Governors. Since 2008 the Fed has been engaged in the most enormous monetary experiment labeled QE and the purchase of more than $3 trillion of bonds. Curiously, CNBC labeled Dr. Yellen’s “ownership” of current policy as a negative. Since the Fed will presumably be navigating an exit from QE during the term of the next Fed chairman, it would seem less disruptive to have the steering performed by someone who helped get us in there in the first place. You can almost hear Fed Chairman Larry Summers, at the first sign of market trouble, proclaiming that had he been in the job since 2008 his intellect would have kept us out of the current situation.

As with many ideas in investing, while we all have opinions on what should be, more interesting is assessing how they will probably be and investing accordingly. My views on the next Fed chairman won’t alter the outcome of that decision. However, exiting QE will represent an enormous communication challenge for either of these candidates. Janet Yellen will be inevitably labeled a dove on monetary policy, and bond investors will likely assume a tightening of short term rates is even farther away than the approximate date of 2015 indicated by the FOMC’s blue dots. The Fed will be either late or very late in restoring rates to neutral. It’s a long time ago now, but I remember in 1987 how the incoming Fed chairman Alan Greenspan was immediately faced with a bond buyers’ strike. Yields rose as investors fretted that nobody could adequately fill the shoes of Paul Volcker, the vanquisher of the inflation dragon. Greenspan was felt to be a poor second act.

As Fed chairman, Larry Summers will be unpredictable. No doubt his prodigious intellect will at some point lead the less intellectually gifted ROTW (Rest of the World) to misinterpret his statements. In either outcome, bond investors will be grappling with less certainty than they were used to. The role of Fed chairman changed in 1975, 1987 and 2006. We’ll soon get only the fourth change in 39 years. It’ll be a big deal. Bond investors probably deserve a little more risk premium in the yields they accept as we head into the next transfer of power.