Peter Fisher, senior director at the BlackRock Investment Institute, and his team discuss what's the road ahead for the Fed.
Peter Fisher, senior director at the BlackRock Investment Institute, and his team discuss what’s the road ahead for the Fed.
One US Federal Reserve exit has become clear; the other one is very much up in the air. The first exit is straightforward: Fed Chairman Ben Bernanke, who faced down the biggest financial crisis since the Great Depression, is handing over the reins to his lieutenant Janet Yellen sometime early next year. The second is fiendishly difficult: Yellen has the challenge of exiting an era of ultra-loose monetary policies.
What happens when Yellen takes over?
The Fed may reduce, or “taper,” its $85bn-a-month bond purchases as early as December-notwithstanding Yellen’s dovish reputation. Yet the new chair is likely to give greater weight to the second part of the Fed’s dual mandate: full employment (over inflation). This will likely mean “low for longer” interest rates.
Yellen will probably drop policy hints during her confirmation hearings. Look for pointers on the merits of monthly bond buying versus “forward guidance” (declaring targets and thresholds for the future funds rate); the right way to measure unemployment; the use of “optimal control” (long-term policy planning and commitments); and the pitfalls of basing guidance on recent economic data.
Another key issue: the pace and communication of tapering. The mere mention of the word tightened monetary conditions-ostensibly more than the Fed expected. It also gave emerging market investors a reality check. The lesson: Fed policy is no panacea for countries dependent on foreign funding.
Yellen may be more forceful than the consensus-driven Bernanke, but it remains to be seen if her colleagues will go along. An added uncertainty: A majority of voting members of the Federal Open Market Committee (FOMC) is set to change in 2014. Yellen has advocated central bankers do more to spur economic activity. Representing the collective FOMC brain trust, will the new chair have to acknowledge the limits of monetary policy?
So what do I do with my money?
Wait and See
We are not clairvoyant on the new Fed chair‘s future moves, and will watch Yellen’s confirmation hearings for policy hints. For now, we stick to our overarching themes:
Selective in Stocks
Markets have likely priced in Yellen’s appointment. Valuations, earnings, economic momentum and uncertainties such as the US budget battles are likely key drivers in coming months. We favor European and Japanese equities as well as US mega caps.
Rethink Fixed Income
Credit (particularly high yield and bank loans) looks more attractive than government debt. The Fed is unlikely to reduce its mortgage buying at more than a snail’s pace, underpinning the sector. We prefer an “unconstrained” (non-benchmark) approach amid (slowly) rising yields.
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