Yellen is handed reins to Fed in bumpy ride to end stimulus

With the Senate’s approval Monday of Janet Yellen to become the first female Federal Reserve chair at the end of the month, she takes on the difficult mission of smoothly ending the unprecedented $4 trillion of stimulus programs launched by her predecessor, Ben S. Bernanke.

In phasing down the central bank’s $75 billion a month of bond purchases, possibly all within the next year, the challenge will be to make the transition back to normalcy without tanking the housing market, the stock and bond markets or the overall economy — a feat that Fed officials themselves acknowledge will be hard to pull off.

Mr. Bernanke, who is scheduled to depart Jan. 31, paved the way for Ms. Yellen by starting the pullout last month, in a move that took global markets by surprise and produced an ecstatic reaction on Wall Street. Mr. Bernanke eased the way by pledging that the Fed would continue to keep short-term interest rates near zero for a long time, even while ending the bond purchase programs that last year drove the rates on 30-year mortgages and long-term Treasury bonds to record lows.

Wall Street’s unexpectedly strong rally in response to the Fed’s December move suggested that stock investors believe the central bank will continue to pump liquidity into financial markets by keeping short-term rates low for as long as two more years. But analysts say Ms. Yellen’s resolve to do so may be tested in the months ahead, especially if economic reports continue to show the economic recovery picking up speed — which could fuel worries about a rebound in inflation.

Tough job

“She has the experience, intelligence, and judgment to be an excellent successor to Ben Bernanke. But she will need to employ all those strengths, and then some, to deal with the challenges facing the nation’s central bank,” said David J. Stockton, an analyst at the Peterson Institute for International Economics.

“We have experienced several episodes in the past few years when a burst of favorable data led to increased optimism [about the economy] that soon proved unwarranted” and forced the Fed to change course, he said.

“The Fed’s premature talk of tapering [bond purchases] in the spring of 2013 illustrates the potential costs of getting too far out in front” before data confirm a nascent improvement in the economy, he said. That episode drove 30-year mortgage rates up from around 3 percent to more than 4 percent and roiled emerging financial markets around the world.

The run-up in mortgage rates cut home sales by about 10 percent from year-ago levels — “not enough to derail the housing recovery, but enough to put a dent in one of the bright spots in an otherwise subdued economy,” Mr. Stockton said.

Ms. Yellen also will have to work hard to carry out the Fed’s regulatory mandates under the banking reform law, including supervising the biggest financial firms in the country to safeguard against financial collapses and bailouts like the ones in 2008 that led to the Great Recession, he said. Mr. Bernanke at the time conceded that the Fed’s failure to regulate loose lending practices during the 2000s housing boom helped bring about the debacle.

“The one indisputable lesson learned from the financial crisis is that regulatory lapses and inattention carry heavy costs,” Mr. Stockton said. “Yellen does not need to micromanage” the regulatory process, he said, “but, like any good chief executive, she needs to be certain that her team understands and is willing to execute her strategic vision.”

International spotlight

Ms. Yellen also will step into the international spotlight making speeches and appearances before Congress that will be followed closely worldwide. Investors will scrutinize every utterance for clues about the central bank’s intentions.

Maintaining a cordial relationship with Congress also will be a delicate task as most conservative Republicans there have opposed the loose lending policies she inherited and are urging her to abandon them. A majority of Senate Republicans voted against her nomination, though it passed handily by 56-27 because of her overwhelming support among the chamber’s Democrats.

Mr. Bernanke offered some advice for Ms. Yellen in his last press conference on how to handle critics in Congress.

“I think the first thing to agree to is that Congress is our boss,” he said, suggesting that offering deference will help to fend off major attempts to change the Fed.

Congressional oversight?

The House Financial Service Committee this year has scheduled a series of hearings on the 100th anniversary of the Fed’s founding with an eye toward recommending changes in the Fed’s structure. Sen. Rand Paul, Kentucky Republican, has actively campaigned for stricter congressional control over the central bank.

Many Fed watchers on Wall Street are apprehensive about congressional attempts to tamper with the central bank, which they fear could lead to a politicization of the all-important process of setting interest rates, which is the Fed’s main way of influencing the economy.

“The Federal Reserve is an independent agency within the government,” Mr. Bernanke said. “It’s important that we maintain our policy independence in order to be able to make decisions without short-term political interference.”

President Obama said he is confident Ms. Yellen will not forget the nation’s 10 million unemployed workers — the intended beneficiaries of the Fed’s stimulus programs — and will draw from her beginnings as a labor economist at the University of California at Berkeley to aid them.

“The American people will have a fierce champion” who will protect them, he said. “I am confident that Janet will stand up for American workers … and help keep our economy growing for years to come.”

Some analysts are skeptical that Ms. Yellen will succeed in her main mission: uneventfully closing out the bloated balance sheet of bond investments that the Fed has undertaken. They say the ailing economy and financial markets have become too dependent on the Fed’s ministrations, and Ms. Yellen will be quickly forced to resume market intervention to prevent an economic decline.

“As he left the stage from his final press conference, Ben Bernanke should have left a giant bottle of aspirin on the podium for his successor Janet Yellen. She’s going to need it,” said Peter Schiff, chief executive of Euro Pacific Capital.

“Without [the bond purchases] to support the markets, in my opinion, the U.S. economy will likely slow significantly, and the stock and real estate markets will most likely turn sharply downward,” he said. “If the economic data begins to disappoint, I believe that Janet Yellen, who is much more likely to be concerned with full employment than with price stability, will quickly reverse course and increase the size of the Fed’s monthly purchases.”