Why Wall Street is relieved Summers is out (and Yellen may be in) at Fed (+video)
The Wall Street rally after Larry Summers bowed out of consideration to lead the Fed is really about the Fed's stimulus program of 'quantitative easing.' Wall Street wants it to last as long as possible, and Janet Yellen would likely close the spigot more slowly.
This week, Wall Street is apparently breathing a sigh of relief.
Markets jumped Monday at the news that Larry Summers, a former Treasury secretary and President Obamaâ€™s assumed first choice to replace outgoing Federal Reserve Chairman Ben Bernanke, had withdrawn his name for consideration of the post.Â The rally continued into Tuesday afternoon, too, just as the Federal Open Market Committee (FOMC), the Fedâ€™s 12-member monetary policymaking body, began its two-day meeting to determine how much it will taper its asset-buying and market-stabilizing program known as â€śquantitative easing.â€ť
Indeed, the fate of this program â€“ or rather, perceptions about how quickly and how much the Fed would scale back its current $85 billion-per-month purchase of long-term government bonds and mortgage-back securities â€“ has loomed behind the marketsâ€™ apparent distaste for the controversial Mr. Summers, whose personal style many find too aggressive and often abrasive.
As Wall Street now turns its attention to Janet Yellen, the Fedâ€™s current vice chairwoman and a leading candidate for the top job, quantitative easing continues to dominate its perceptions of the next central banking chief. Ms. Yellen, many market watchers believe, would scale back the Fedâ€™s stimulus program more slowly than Summers might have, thus keeping the easy-cash spigot flowing longer.
â€śActually, the jump on Wall Street may have been more about eliminating uncertainty than a cry for Yellen over Summers,â€ť says Walter Schubert, professor of finance at La Salle University in Philadelphia.
â€śQuantitative easing has the virtue of keeping interest rates low and thus bond prices and stock prices high,â€ť says Professor Schubert, who teaches a class on the history of the Federal Reserve. â€śSummers appeared to doubt the efficacy of quantitative easing â€“ though the question may not be why is it doing relatively poorly as much as, without it, things would be awful.â€ť
So the marketâ€™s robust reaction, experts say, has more to do with maintaining the current environment, which has been a boon for Wall Street investors, even as the larger economy has moved at a slugâ€™s pace.
â€śWall Street is very much interested in where their own bread is buttered,â€ť says Michael Driscoll, clinical professor and senior executive in residence in the Robert B. Willumstad School of Business at Adelphi University in Garden City, N.Y. â€śWall Street has had a pretty good run the last couple of years. Despite a lot of people being put out of work and the job market shrinking, the overall markets have done pretty well.â€ť
Fueled by the Fedâ€™s miniscule prime interest rate as well as its asset purchasing â€“ by which the central bank in effect â€śprints moneyâ€ť for other banks' reserve funds, and then uses this materialized cash to buy troublesome assets that can drag down the economy â€“ the markets have been awash in cash.
This makes conditions ripe for a sudden burst of inflation, economists say.
â€śThatâ€™s the issue I see on the longer side,â€ť says Ernie Patrikis, a former general counsel of the New York Federal Reserve and a current partner with White & Case, a New York-based law firm. â€śWe keep saying today we see no signs of inflation, but the Fed and the economy is this huge tanker, and you donâ€™t wait 'til you are in the harbor to make a turn.â€ť [Editor's note: The original version of this story misspelled the name of Ernie Patrikis.]
Yet consumer prices hardly jumped at all this summer, rising a slight 0.1 percent from July to August. Over the past year, too, consumer prices rose a modest 1.5 percent, according to the Bureau of Labor Statistics, in a report released Tuesday.
Such good news about inflation will indeed allow the Fed to take its time in scaling back its program of quantitative easing. Most observers believe the FOMC will on Wednesday cut its monthly asset purchasing only about $10 billion â€“ a slight tap on the brakes rather than a definitive move back to pre-crisis normalcy.
â€śBut everybody knows that it has to end at some point,â€ť says Mr. Driscoll. â€śEven the term 'tapering' implies that itâ€™s not going to be an on or off switch.... Itâ€™s going to be carefully orchestrated, with careful signals given, so the markets arenâ€™t caught by surprise â€“ because if it's one thing the market dislikes, itâ€™s to be caught by surprise.â€ť
If Wall Street wants to maintain the status quo to keep interest rates low and to keep the easy cash flowing, left-leaning politicians prefer Yellen for a different reason. They like that she generally places a greater emphasis on higher employment than on low inflation.
â€śThe general dilemma with monetary policy is the sort of dual mandate of inflation control and concern with unemployment,â€ť says James Kahn, the Henry and Bertha Kressel Professor of Economics at Yeshiva University.
â€śJanet Yellen puts much more weight on the concern about unemployment,â€ť he continues. â€śSo her pattern has been, whenever there has been a question about which way to go ... she generally sides with the view that, well, we want to make sure that we donâ€™t have a recession or that we donâ€™t stall the recovery â€“ so sheâ€™s more concerned with unemployment than with inflation....
â€śAgain, had Summers been nominated, the markets would have immediately reacted with the 10-year Treasury rates going up, anticipating a sooner end to this quantitative easing. But with Yellen, that concern was eased.â€ť
In the end, Summers was seen as too unpredictable and volatile for an industry that values predictability and stability.
â€śIn my mind, thereâ€™s a calming effect to the Fed chairman â€“ at least in the way that [former Fed chair Alan] Greenspan and Bernanke had played that role,â€ť says Jon Najarian, senior economic analyst at the Chicago office of Capital Gold Group. â€śAnd I would think that Janet Yellen would be much the same.... Larry Summers is more likely to speak off the cuff, rather than stick to the script.â€ť