Federal Reserve officials will gather in their Washington boardroom today and Wednesday to decide on policies that will unfold over the next two to three years without knowing who will lead the institution during that time.
Sunday’s announcement that Lawrence Summers has withdrawn from Obama’s list of candidates to succeed Fed Chairman Ben S. Bernanke threatens to weaken the central bank’s policy message by leaving the succession unsettled just as it considers scaling back record accommodation.
Policy makers will decide at their meeting this week whether the economy is strong enough to begin tapering $85 billion in monthly bond purchases. As they do so, they will use so-called forward guidance to convince investors they can keep interest rates low for as long as it takes to bring down unemployment so long as prices remain in check.
“The biggest problem with this period of indecision about Bernanke’s successor is that it does have an effect on the Fed’s ability to conduct monetary policy,” said Ward McCarthy, chief financial economist at Jefferies LLC in New York and a former Richmond Fed economist. “The market rightfully questions forward guidance, and that reduces the effectiveness of monetary policy.”
Officials will probably lower their estimates for growth for this year and next for the third consecutive time. To keep bond yields from rising and threatening growth, officials will need to emphasize their message that the benchmark interest rate is likely to remain low.
Ten-year Treasury yields have jumped almost 1 percentage point since May 21, the day before Bernanke said the central bank could “take a step down in our pace of purchases,” in the “next few meetings.” The rise in yields in turn has pushed up interest rates on home loans, threatening to sap a housing revival that has helped drive the economic expansion.
In July, Obama mentioned three possible nominees for the chairmanship: Summers, 58, Fed Vice Chairman Janet Yellen, 67, and Donald Kohn, 70, a former Fed vice chairman who is now a senior fellow at the Brookings Institution.
With Summers out of the picture, investors are betting that Yellen is now the top contender for the job, according to Brian Jacobsen, chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wis.
The Dow closed up 118.72 points, at 15,494.78, on Monday.
Summers, who served as Treasury Secretary under President Bill Clinton and was Obama’s top economic adviser in his first term, would have tightened Fed policy more than Yellen, according to a Bloomberg Global Poll last week.
“Markets were priced for the likelihood of a Summers nomination, primarily for the notion that he might raise interest rates sooner than perhaps other candidates, including Janet Yellen,” said Tony Crescenzi, a portfolio manager and strategist at Newport Beach, Calif.-based Pacific Investment Management Co., which manages the world’s biggest bond fund.
Yellen isn’t necessarily the “de facto nominee,” said Mark Calabria, a former top aide on the Senate Banking Committee and now director of financial regulation studies at the Cato Institute in Washington.
Former Treasury Secretary Timothy F. Geithner isn’t interested in serving as chairman, according to a person familiar with Geithner’s thinking. Geithner has consulted with Obama on the nominee.
Allan Meltzer, a professor of political economy at Carnegie Mellon University’s Tepper School of Business in Pittsburgh and the author of a history of the central bank, said the frenzy surrounding Summers’ possible nomination was unprecedented.
“We’ve never seen anything like it,” he said. “What is missing from the discussion all along is: What are the main challenges that the Fed has to face?”
More than four years after the recession ended, unemployment stood at 7.3 percent in August, and the annual inflation rate has been at least a half percentage point below the Fed’s 2 percent target since December.
Policy makers have pledged they won’t consider raising the federal funds rate as long as unemployment is 6.5 percent or higher. In July, they discussed lowering that threshold before any decision on raising borrowing costs.
The Fed’s balance sheet has exploded to a record $3.66 trillion as it has bought up hundreds of billions of mortgage-backed securities and U.S. Treasury bonds to try and keep long-term interest rates low.