Selecting The Next Federal Reserve Chair: When And How
Federal Reserve Chairman Bernanke's term expires January 31, 2014. While his continuation as Fed chair cannot be ruled out, he has given no public indications that he plans to seek another term and most market participants - as well as many members of Congress in last week's Humphrey-Hawkins hearings - seem to believe he will retire from public service early next year. As Goldman notes, the announcement of the next Chair of the Federal Reserve seems most likely to come in October, though nominations for Fed Chair have been announced as early as five months before the current term expires and as late as less than a month before expiration. There does not appear to be much risk to the Senate's ultimate confirmation of whomever the President chooses, though the Fed nominations have become more politically controversial over the last few years, which is likely to lengthen the confirmation process. Following previous confirmations, financial market volatility has typically increased slightly, though whether this occurs following the upcoming transition will of course depend on who is nominated.
Via Goldman Sachs,
In what follows, we address some of the frequent questions that have come up regarding the process of selecting a new chair.
When will the President make the nomination?
We would imagine that the next nomination will come in late September or October, at the long end of the range of the lead times of prior nominations. The Senate confirmation process has become more difficult in recent years, and Chairman Bernanke’s most recent nomination in 2009 was announced four months before the end of the term. In light of the political interest in Congress in the upcoming nomination, the process seems likely to last at least as long, so it will probably require the same amount of lead time. Another consideration may be the crowded policy calendar this fall:
- September 17-18: FOMC meeting with press conference. Our baseline expectation is that the Fed will announce tapering of asset purchases at this meeting, as well as a strengthening of forward guidance. While there is no reason that the nomination announcement could not come before this, the White House might want to wait until after what is generally considered to be a key monetary policy event before making an announcement.
- September 30: End of the federal fiscal year. The political parties have major differences in their preferred spending levels and treatment of sequestration for the coming fiscal year, which starts October 1. The period immediately preceding this may be dominated by discussion of reaching a last-minute agreement to avoid a temporary government shutdown.
- Late October: Debt limit. We have updated our projections, and the Treasury still looks on course to exhaust its financing capacity under the debt limit sometime in late October or the first few days of November.
- October 29-30: FOMC meeting. This one will not be followed by a press conference.
- December 17-18: FOMC meeting with press conference. If the FOMC does not announce tapering in September, the focus is apt to shift to the next meeting with a press conference in mid-December. In light of the congressional schedule, it is highly likely that the confirmation process for the next Fed chair will have commenced by this point.
As Exhibit 1 shows, the timeline of the nomination and confirmation process of Fed chairs has varied over the years, but has become somewhat more drawn out recently. The first formal step in the process is the President’s announcement of who he intends to nominate for Chairman. The timing of this relative to the end of the current Chairman’s term has varied in the past, but typically comes at least two months before the term expires and sometimes as long as five months prior. Once the announcement has been made, the formal nomination typically follows a few weeks later.
Once the Senate has received the nomination (the House does not play a role in confirming presidential nominations), the Senate Banking Committee, chaired by Sen. Tim Johnson (D-SD) will hold a confirmation hearing. These typically occur a few weeks after the formal nomination. However, a vote on the nominee is not conducted at the nomination hearing. Instead, Senate committee members will question the nominee, and will often submit additional detailed questions to be answered in writing. These "questions for the record" have become much more time-consuming in recent years, with some recent cabinet-level nominees receiving hundreds of questions to answer in writing. Fed nominees are typically not subjected to nearly as many questions, but will probably have to respond to at least a few. This, along with other factors, typically results in a delay of another several weeks between the committee hearing and vote. After the committee vote, the final step is a confirmation vote on the Senate floor. If recent precedents are any guide, the final Senate vote will probably not come until January.
In the unlikely event that the Senate has not approved the nomination by the time Bernanke's term as Fed Chairman expires January 31, 2014, it should be noted that his term as a member of the Federal Reserve Board of Governors runs until 2020, so he could continue to serve as a board member, including on the FOMC (while it is not relevant in this case, even if his term were to expire, he would be eligible to remain on the board until a successor was confirmed). The law is somewhat unclear on who would chair the Fed Board in such an event; in some interpretations the vice-chair (currently Janet Yellen) would take over as acting chair if the Senate had not yet confirmed a successor. Regarding the FOMC, the Federal Reserve Act states only that the members of the Board of Governors serve on the FOMC, but it does not specify who chairs the committee. The Fed's own rules state that the vice-chair of the FOMC (currently NY Fed President Bill Dudley) chairs the committee in the absence of the Chairman. The FOMC elects its chair and vice-chair at the first meeting of each year, which in 2014 is scheduled for January 28-29 (a couple of days before Bernanke's term expires). Conceivably, if it is clear by the time of the first meeting that the new chairman will not be confirmed in time, the committee would simply elect Bernanke as chairman once again at the first meeting. Of course, the likelihood of any of these contingencies actually coming into play is low.
Is there any risk that the next nominee would not be approved?
While Senate confirmation of a nominee for Federal Reserve Chairman cannot be taken for granted the way it had been until recently, we do not think the Senate is yet at the point where it would actually turn down a nominee for the position. As shown in Exhibit 2, Chairman Bernanke's nomination for a second term was confirmed with only 70 votes in the Senate, far below the typical level of support for a Fed Chairman. However, while this is unusual for a Federal Reserve official, it is not uncommon for other cabinet nominees.
In fact, many high-profile cabinet appointments are confirmed with less support, and while some of the shift may be due to a greater political focus on monetary policy over the last few years, part of it may also reflect the greater difficulty nominations have in the Senate more generally. In that regard, it is also worth noting that while the Senate has retreated from its "nuclear option" rules change that would lower the threshold from 60 votes to 51 votes for executive appointments, this could still re-emerge later this year if other nominations are delayed. If such a change were made, it would allow a simple majority in the Senate (i.e., Democrats) to approve nominations and would prevent the minority party (Republicans) from blocking nominations through filibuster.
How reliable is the early punditry on likely replacements?
Anecdotally, it seems that while the conventional wisdom sometimes gets it wrong, the eventual nominee is usually at least noted as a contender in the financial press for a while before the decision is made. The two most obvious examples to look back on are the replacement of Paul Volcker and Alan Greenspan, in 1987 and 2005, respectively. One difference between them is that while Greenspan was term-limited and thus his departure was certain, there was still some uncertainty regarding whether Volcker would stay on until the President actually announced his replacement.
In early 1987, the expiration of Paul Volcker's third term as Fed Chairman was approaching, and financial journalists were writing about a number of candidates to replace him, with Alan Greenspan's eventual nomination considered possible, but not the most likely outcome. At the start of that year, a poll of institutional investors put Manuel Johnson, then serving as Vice Chair of the Fed, as the leading contender. In February, about four months before the announcement was made, a Wall Street Journal article listed Johnson and Gerald Corrigan, then President of the NY Fed as likely picks, while noting that "White House Officials also mention New York-based economic consultant Alan Greenspan and former Citicorp Chairman Walter Wriston as potential nominees." By April -- roughly two months before the announcement-- Greenspan was described in press accounts as "a favorite" for the position, though institutional polls still showed other candidates more likely to be nominated. By the time of the announcement, Greenspan was seen as the leading candidate, though it was still not entirely clear whether Volcker would seek another term.
In August 2005, several months ahead of the expiration of Chairman Greenspan's term in January 2006, Bernanke, Martin Feldstein of Harvard, and Glenn Hubbard of Columbia were listed in an article in the Wall Street Journal as "the three candidates mentioned most often," along with other names considered less likely such as White House economic advisor Lawrence Lindsey. Unlike the 1987 nomination, by 2005 online prediction markets such as intrade.com traded contracts on the Fed nominee. Bernanke was seen as the most likely candidate throughout most of the summer and fall. That said, there was considerable uncertainty expressed in those prediction markets, with a few other candidates also appearing likely at points along the way; Bernanke's probability of nomination hovered around only 40% in the three months leading up to the announcement.
This time around, most accounts in the financial press list:
- Fed Vice Chair Janet Yellen,
- former White House economic advisor and Treasury Secretary Larry Summers,
- former Fed Vice Chair Roger Ferguson, and
- former Treasury Secretary and NY Fed President Tim Geithner
as leading contenders for the job.
How do markets react around Fed transitions?
Historically, Fed transitions have been associated with more volatile markets. Exhibit 3 shows the median monthly realized volatility (dashed lines) in equity and bond markets around prior Fed transitions. As shown in the exhibit, significant increases in volatility have occurred following Fed transitions, although the median trend is much more subdued, with a slight uptick in volatility in the 10-year Treasury and a somewhat more consistently elevated level of volatility in US equities.
Of course, how the market reacts to the upcoming announcement and confirmation process will depend mainly on whether market participants have successfully anticipated the nomination and whether they have a clear understanding of the new Chair's policy views.
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