Hedge Funds Seek Insight Into What Summers Would Do at FedJoshua Zumbrun and Jeff Kearns
Investors are increasingly seeking advice on how the potential nomination of Lawrence Summers as chairman of the Federal Reserve instead of Vice Chairman Janet Yellen might influence monetary policy and financial markets.
Inquiries about Summers’s chances “are picking up a lot,” said Matthew Benjamin, an analyst at Medley Global Advisors LLC in Washington, a firm that provides political intelligence to hedge funds. “Wall Street is very interested in this, and there is a perception that there is a difference between Yellen and Summers” in their approach to monetary stimulus.
Chairman Ben S. Bernanke’s term ends in January, and his successor may take over as the Fed pares back its monthly bond purchases of $85 billion, a prospect that has rocked financial markets from New York to Jakarta. Some investors say Treasury yields have risen in reaction to the possibility of a Summers nomination and could go higher.
“The market was comfortable with a Yellen appointment and is needing to grow comfortable with what a Larry Summers appointment might mean,” said Leo Grohowski, chief investment officer of New York-based BNY Mellon Wealth Management, which oversees more than $175 billion. “It’s one of the uncertainty factors that the market has to deal with that many, a few months ago, didn’t think we had to deal with.”
Interest rates on Treasury debt and mortgages have climbed since May 22, when Bernanke told the Joint Economic Committee of Congress that the central bank may begin tapering the pace of asset purchases, known as quantitative easing, at one of the Fed’s “next few meetings.”
The yield on the 10-year Treasury note rose to 2.75 percent yesterday from 1.63 percent on May 2, the lowest level of the year. The national average 30-year fixed-rate mortgage has risen to 4.51 percent from 3.35 percent in early May, according to Freddie Mac.
The U.S. bond market is facing its worst losses in at least 37 years. Through Aug. 28, the Bank of America-Merrill Lynch U.S. Broad Market Index was on pace for a 4.8 percent annual decline, the biggest loss since the index began in 1976.
The possibility of a Summers chairmanship has contributed to the increase in borrowing costs because he is seen as likely to end the Fed’s quantitative easing sooner than Yellen would, said Krishna Memani, New York-based chief investment officer of fixed income at Oppenheimer Funds Inc., with about $208 billion under management.
“Tapering with the prospect of a Summers Fed chairmanship clearly are the two big drivers of rates rising and the yield curve steepening,” said Memani.
Tony Fratto, a U.S. Treasury assistant secretary in the George W. Bush administration and the founder of consultants Hamilton Place Strategies in Washington, said some clients “are troubled at the prospect. Some are just curious and trying to figure out the future.”
“Clients have been asking for about three months whether Summers can be confirmed,” he said.
While former Treasury Secretary Summers, 58, has no record making monetary policy, he expressed skepticism about the effectiveness of QE in an April conference hosted by Drobny Global Advisors.
By contrast, Yellen’s views are well known after more than a decade at the central bank. Yellen, 67, was a Fed governor from 1994 to 1997, president of the San Francisco Fed from 2004 to 2010 and vice chairman since 2010.
She has been an architect of the current stimulus campaign and Fed communication strategy and has never dissented from a monetary policy decision under Bernanke.
“We know with Yellen that she will continue with their current program,” Memani said. “With Summers it’s a lot less certain.”
Bernanke has assured investors that paring purchases doesn’t signal an increase in the benchmark interest rate, which policy makers forecast will remain near zero until 2015. As the Fed begins to move away from bond purchases to boost the economy, it will rely on more on guidance on the future path of interest rates as a policy tool.
The increase in borrowing costs “serves to weaken the Fed’s message when there’s a question about continuity, just when the Fed is moving to rely more on that particular tool” of rate guidance, said Laura Rosner, a U.S. economist at BNP Paribas SA in New York and a former researcher at the Federal Reserve Bank of New York.
Rosner and colleagues at BNP Paribas, including former Fed economist Julia Coronado, estimate that the yield on the 10-year Treasury note would rise about 50 basis points if Summers were nominated instead of Yellen. A basis point is 0.01 percentage point. That would cause the firm to lower its forecast of gross domestic product growth over the next two years by 0.5 to 0.75 percentage point and would mean 350,000 to 500,000 fewer jobs, they wrote in a note published yesterday.
As recently as an Aug. 9-13 Bloomberg survey of economists, Summers was seen as unlikely to be selected to lead the Fed. Twenty-five percent of economists said Summers would be President Barack Obama’s choice, compared with 65 percent for Yellen. Ten percent of the 63 economists in the survey thought Summers would be the best pick, compared with 53 percent for Yellen.
Fratto said Summers is an “impressive economist and can be a successful Fed chair.” At the same time, Fratto said, Summers may arouse opposition from members of both parties, with some Democrats viewing him as a proponent of financial deregulation.
When he was deputy Treasury secretary in 1998, Summers helped thwart an effort by Brooksley Born, then-chairman of the Commodity Futures Trading Commission, to consider regulating over-the-counter derivatives. That market ballooned to a notional value of almost $600 trillion in 2007 from about $28 trillion at the time of Born’s proposal. Largely unregulated trades of those contracts helped fuel the 2008 financial crisis.
Fratto is also trying to debunk the idea for clients that Republicans will easily vote for Summers. Many are concerned about his independence from the White House, he said.
If Republicans thought “Bernanke was carrying water for the White House, then what are they going to think of Summers?” said Fratto.
Bernanke’s confirmation for a second four-year term in 2010 prompted the most opposition of any nominee for the post in the 100-year history of the central bank. Twelve Democrats joined 18 Republicans in opposing Bernanke amid anger over the central bank’s role in bailing out large banks during the financial crisis.
This time, 20 members of the Senate Democratic caucus endorsed Yellen for chairman in a letter to the White House on July 26. The letter described Yellen as willing “to challenge conventional wisdom regarding deregulation,” an implicit criticism of Summers, who wasn’t mentioned in the letter.
Summers, who was Treasury secretary from July 1999 to January 2001, returned to government in 2009 as National Economic Council director during Obama’s first term.
“If it is Summers, he has some work to do,” Norman Ornstein, resident scholar at the American Enterprise Institute, a free-market group in Washington, said in an interview earlier this month. Yet he said Summers probably would get confirmed in the Senate, which Democrats control 54-46.
“You may see some grumbling,” Ornstein said, “but I think they get the votes.”
Summers may encounter difficulty in the Senate Banking Committee, where Democrats dominate 12-10.
Committee member Sherrod Brown, an Ohio Democrat, led the campaign to send the Senate Democrats’ letter to the White House. Another Democrat on the panel, Jeff Merkley of Oregon, signed the letter and questioned whether it would be “appropriate” for Obama to nominate Summers, whom he described as “a life-committed deregulator.”
A third Democrat on the committee, Elizabeth Warren of Massachusetts, signed the letter endorsing Yellen. A group of 37 House Democratic women, led by California Representative Maxine Waters, also sent a letter to the White House July 31 urging Obama to appoint Yellen. The House has no role in confirmation.
Senate Majority Leader Harry Reid, a Nevada Democrat, said after a July 31 meeting between Obama and Senate Democrats that party members in his chamber would support the president’s choice for the Fed “no matter who it is.”
Joseph Engelhard, a former Treasury Department official who is now senior vice president at Capital Alpha Partners LLC, also predicted that few, if any, Senate Democrats would go so far as to vote against Obama’s eventual nominee.
“I can’t imagine whoever Obama nominates wouldn’t have the full support of all Senate Democrats -- maybe you lose one or two,” Engelhard said. “This is all trying to influence the process rather than raising a red flag.”