The Yellen Fed

Zach Pandl, Portfolio Manager and Strategist | October 9, 2013

  • President Obama to nominate Janet Yellen for Fed Chair.
  • Yellen has strongly supported the Fed’s unconventional easing measures in recent years, and we expect that her nomination will therefore be interpreted as favorable to duration and carry trades.
  • Yellen has described an “optimal control” framework, which could indicate a coming revision to the current structure of the FOMC’s forward guidance.

According to press reports, President Obama plans to nominate Janet Yellen as the next Fed Chair at a White House event tomorrow. Yellen currently serves as Vice Chair of the Federal Reserve Board and her views are already widely known by market participants. If anything the announcement should reduce uncertainty around the outlook for U.S. monetary policy. Yellen has strongly supported the Fed’s unconventional easing measures in recent years, and we expect that her nomination will therefore be interpreted as favorable to duration and carry trades.

Here is a brief overview of the issues we will explore in more depth in the coming weeks:

  • The dove question: Monetary policy is a complex thing, and many economists scoff at the idea that an individual’s views can be reduced to labels like “hawk” and “dove”. Still, to the extent this shorthand has meaning, I believe it is fair to label Yellen a dovish central banker. This is not a normative statement: many people believe the Fed should be much more aggressive than it is today, and that the idea of tapering QE was a folly. But I think most economists would agree that Yellen falls to the left of center—e.g. closer to Paul Krugman than John Taylor, and probably closer to Krugman than Greg Mankiw.
  • Pivot to the center: That being said, watch for a possible pivot to the center from Yellen in her public comments over the next couple of months. This may be a necessity of both the nomination process and her future responsibilities corralling a vocal committee.
  • Participation rate: The falling labor force participation rate has divided Fed officials, with some arguing that the decline is “structural”—and thus outside the scope of monetary policy—and others arguing that the decline is “cyclical”—and thus within the scope of monetary policy. We do not know exactly where Yellen stands on this issue. On the one hand, the fact that the FOMC introduced unemployment rate-based policy rules on her watch (and while she chaired the Fed’s subcommittee on communication issues) suggests she could lean toward the “structural” arguments. On the other hand, the economist that serves as Yellen’s special advisor at the board and quasi chief of staff (Andrew Levin) wrote a paper this year which forcefully argued the cyclical case. Her take on this topic will be one of the most closely watched questions in the nomination hearings.
  • Optimal control: In a series of speeches last year, Yellen described the policy outlook as an “optimal control” problem in which the Fed commits to a path for the funds rate which achieves the “best” outcome in terms of unemployment and inflation (given a certain model structure). This framework appears to have guided committee views on the appropriate trajectory for the funds rate in their forecasts, including those presented at the September FOMC meeting. The optimal control framework will be central for understanding the evolution of policy under the Yellen Fed. It may indicate a coming revision to the current structure of the FOMC’s forward guidance.
  • Next Vice Chair: With Yellen promoted, President Obama will also need to nominate a new Vice Chair (as well as a couple more governors). In the past this person has taken a central role shaping policy, so the Vice Chair nomination will likely affect market perceptions of the new FOMC. For example, Governor Stein would be seen as balancing Yellen’s policy views.

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