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Will Janet Yellen Make A Difference In Heading Up The Fed?

It is now widespread public knowledge that Janet Yellen will be the new chairperson of the Federal Reserve.(1)(2)(3) This was signaled by the U.S. government months in advance, particularly since the withdrawal of Lawrence Summers from the race.(4)(5) The fact that Ben Bernanke did not attend the annual meeting at Jackson Hole, Wyoming (6) and that his term was expected to expire at the end of January 2014 are also indicators that Janet Yellen's appointment is not really news as someone has to take over Ben Bernanke's job.

There will not be a huge difference between Yellen and Bernanke - in fact Janet Yellen will likely be the new and improved Ben Bernanke: taking Quantitative Easing to new heights and more extremes, or perhaps dialing it down more aggressively than Bernanke would have done. Why? She has constantly been in agreement with the QE idea and she supports the notion of higher inflation being necessary and positive in this type of environment. (7)(8)(9)(10)

On the flip side, there are two exceptions to this line of thinking. The first one is if the U.S. economy does very well in 2014, and the market is able to absorb the Fed tapering without a large correction. The second one is that Yellen decides that QE is not a good thing and decides to tighten even with an adverse market reaction because it is necessary. This is possible because when interest rates were being tightened in the 1990's, Yellen voted to raise rates 27 times. (8) The message here is that Yellen can change course and may not encourage QE until the bitter end as the market may assume. Neither of these scenarios is likely, but so far the market believes that the first exception is under way.

Has the market already factored in Yellen's appointment? The fact that this news created like reaction says that the answer is yes. She was chosen to cause the least amount of disruption to the fragile U.S. recovery. If the new head of the Federal Reserve were more hawkish, saying things such as higher interest rates are a forgone conclusion, or QE would be reversed quickly, the market reaction would have been swift to the downside long before now. It is ironic that the tapering measure that was floated in 2013 will actually take effect at the same time as Janet Yellen takes over the Federal Reserve, in January 2014. (11)(12) What is even more ironic is that the market is expecting tapering even though they have a new chairperson who would support QE even more than Bernanke would. The reason why these ironies exist so far is because the U.S. economy is expected to recover. Should this recovery not happen, there will be a very different story - go back to summer of 2013 and note the market reaction.

What does this mean for you? In the short term, interest rates are creeping higher so your portfolio should be ready for this possibility. In the longer term, if this tapering works, the stock market will correct. The Federal Reserve is betting on doing it slowly, in an orderly fashion, but this is like trying to control the exploding of dynamite. It is possible, but very difficult to do over a long period of time. This means there will be more volatility and sideways movement as the market tries to follow what will happen next. If QE is expanded again, it will be exaggerated in contrast to Bernanke and inflation will be allowed to move higher than under Bernanke. Encouraging higher inflation is another way of trying to control an explosion. When the fuse is lit, expect things to move more quickly on the up or the down side with Yellen versus Bernanke, all else being equal.

Sources:

1) http://www.reuters.com/article/2014/01/06/us-usa-fed-yellen-idUSBREA0506C20140106

2) http://www.bloomberg.com/news/2014-01-06/yellen-confirmed-by-u-s-senate-to-become-fed-chairman.html

3) http://www.washingtonpost.com/business/economy/janet-yellen-confirmed-as-next-fed-chief/2014/01/06/14b38582-76f2-11e3-8963-b4b654bcc9b2_story.html

4) http://www.abc.net.au/news/2013-09-16/larry-summers-withdraws-from-fed-chairman-race/4959772

5) http://www.ft.com/intl/cms/s/0/8a46d28a-1e47-11e3-85e0-00144feab7de.html#axzz2ppLgc8W9

6) http://www.bloomberg.com/news/2013-08-22/jackson-hole-without-bernanke-to-focus-on-global-monetary-policy.html

7) http://www.bloomberg.com/news/2013-11-14/yellen-says-it-s-imperative-to-promote-a-strong-recovery.html

8) http://www.usatoday.com/story/opinion/2013/11/17/yellen-federal-reserve-quantitative-easing-editorials-and-debates/3621197/

9) https://www.ups.com/mrd/promodiscount?loc=en_CA&promoCd=BC5MZ6GG8

10) http://www.reuters.com/article/2014/01/09/us-usa-fed-yellen-time-idUSBREA080NO20140109

11) http://www.bloomberg.com/news/2013-12-19/fed-seen-tapering-qe-in-10-billion-steps-in-next-seven-meetings.html

12) http://www.reuters.com/article/2014/01/08/us-usa-fed-reverserepo-idUSBREA0717V20140108

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.