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PIMCO: Policy Uncertainty on the Rise


A possible government shutdown, the debt ceiling increase, and the Federal Reserve chairman nomination -- all events that could push volatility much higher.

Federal Reserve chairman nomination: Lastly, since current Fed Chairman Ben Bernanke is expected to step down when his second term is complete in January 2014, the Obama administration will likely nominate a new chairman this fall. There is no specific deadline – only time enough to allow for Senate consideration and confirmation before the end of January.

Speculation abounds over who will be appointed, with the press increasingly framing the debate between Fed Vice Chair Janet Yellen and former Treasury secretary Larry Summers. While PIMCO will not lean in on this debate and is not in the business of endorsing candidates for government positions, we do believe the outcome is significant for the markets.

Until recently, the market was pricing in a Yellen nomination. In many ways, the market sees her as the obvious choice: She would be the least disruptive candidate and would provide the most continuity, since her outlook and approach to monetary policy are well-known. Politically, she gives President Obama, who has been criticized for appointing too few women to leadership posts, the opportunity to nominate the first-ever female Fed chair, breaking a significant glass ceiling. Importantly, Yellen has very impressive academic and professional credentials and is not weighed down with a lot of political baggage, making a Senate confirmation process likely straightforward.

Recent press reports, however, have the market reconsidering these prior assumptions on the likely nomination. What appeared to be trial balloons from the administration regarding Larry Summers, followed by the president defending Summers' record publicly, have made clear that the debate is far from over, and Summers, who is closer to the president's inner circle, could in fact be the front-runner.

Gauging the potential market impact depends on how the market characterizes the monetary policy framework of each candidate.

Markets perceive Janet Yellen to be a dovish version of Ben Bernanke. Her "optimal control" model for monetary policy has often appeared to be the driving force behind the Fed's decisions. In layman's terms, this model calls for more central bank aggressiveness than that of traditional models to generate employment growth, even if it means accepting higher than the targeted 2% inflation rate for a period of time. Relative to other central bankers, she has demonstrated a willingness to experiment, to rely upon models and to be bold.

Summers, due to a lack of direct monetary policy experience, is much less known to markets. Most investors would also characterize him as a "dove," but not to the degree of Yellen. While Summers has generally supported the Fed's accommodative policies, he has been critical at times of the efficacy of quantitative easing. He has often called on fiscal agents to provide more economic heavy lifting rather than depending solely upon monetary policy. Many believe a Summers Fed would be less focused on consensus-building and transparency, which have been hallmarks of the Bernanke (and Yellen)-led Fed.
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