RANDY FREDERICK: It seems like the Federal Reserve is always part of the discussion when it comes to forecasting the markets. Kathy Jones joins me for the October 10th Schwab Market Snapshot, to give us her take on some of the upcoming changes with regard to the Chairman, the members, and the recently announced balance sheet reduction plan.
So, Kathy, there is a lot of speculation going on about who the next Chair of the Federal Reserve might be. And, in fact, we might even get an announcement as early as this week. Can you tell us who the main contenders are, and is there any chance Janet Yellen might stick around?
KATHY JONES: Well, as far as we know, Randy, there are four main contenders, and Janet Yellen is one of them, along with Jerome Powell, who is also a governor at the Federal Reserve. And then there are two outside candidates, Kevin Warsh and Gary Cohn, who are well-known in economic circles, but not so much, maybe, to the public.
Yellen and Powell represent consistency in terms of policy because they’ve been at the Fed for a while. Warsh and Cohn, a little less well known in terms of monetary policy views, but we do know that both of them have advocated reducing the regulatory oversight for banks.
RANDY: Well, I think most people know that the Fed sets interest rates, and, of course, that impacts the bond markets. But my question is, how much does that really matter to the average investor?
KATHY: Well, it is important for the average investor because the Fed sets the base lending rate or the risk-free rate, and that’s the basis for other rates in the economy. So if you have an auto loan, or a mortgage loan, or a business loan, it’s going to be influenced about how the Fed is setting policy.
Also, the head of the Federal Reserve communicates policy to the public and to the market, so it’s a very important role. Particularly now, as we’re moving towards reducing the balance sheet that the Fed has, it’s an important transition for the economy and for the markets. So it’s going to be important to know who is going to be handling that.
RANDY: Well, since you mentioned the balance sheet reduction plan, at their September policy meeting, the Fed said that was supposed to start this month. So can you tell us exactly what that means, and could that cause bond yields to rise?
KATHY: Well, the way it works is the Fed has 4½ trillion dollars in their balance sheet. And, currently, they have been reinvesting the principal on the bonds that they hold in order to keep the balance sheet large. They’re going to stop that reinvestment process and gradually reduce their balance sheet by letting those bonds mature and roll off.
Now, what that means, of course, is that when the Treasury is selling bonds at auction the Fed won’t be buying as much. And so other buyers are going to have to come into the market to replace the Fed, and that could drive up interest rates. It’s likely to do that. And so, you know, the Fed has estimated that the influence of quantitative easing was to reduce 10-year treasury yields by about 1%. So it’s logical to think that over a period of years that rates will move back up by about the same amount. But other factors are always important, particularly growth and inflation.
RANDY: Thank you so much for your insights, Kathy. And speaking of insights, you can read more from Kathy in the Insights & Ideas section of Schwab.com. You can follow Kathy on Twitter @KathyJones, and, of course, you can always follow me on Twitter @RandyAFrederick. We’ll be back again. Until next time, invest wisely. Own your tomorrow.