| Bonds Online |
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| 5/10/2013Market Performance |
| Municipal Bonds |
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S&P National Bond Index
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3.00% |
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S&P California Bond Index
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2.96% |
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S&P New York Bond Index
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3.13% |
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S&P National 0-5 Year Municipal Bond Index
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0.70% |
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| S&P/BGCantor US Treasury Bond |
400.09 |
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| Income Equities: |
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| Preferred Stocks |
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S&P U.S. Preferred Stock Index
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848.03 |
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S&P U.S. Preferred Stock Index (CAD)
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636.26 |
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S&P U.S. Preferred Stock Index (TR)
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1,701.05 |
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S&P U.S. Preferred Stock Index (TR) (CAD)
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1,276.26 |
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| REITs |
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S&P REIT Index
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174.07 |
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S&P REIT Index (TR)
|
425.30 |
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| MLPs |
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S&P MLP Index
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2,469.58 |
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S&P MLP Index (TR)
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5,428.50 |
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See Data
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Bond Market Comentary |
The Fed in Transition
October 26. UBS
The Fed in Transition* President Bush nominated Ben Bernanke to role of Fed Chair:
By nominating Ben Bernanke to succeed Alan Greenspan, the President
chose someone well known in policy, academic and financial market
circles. Dr. Bernanke's qualifications are very strong, and, in our
view, he will likely be confirmed by the Senate with relative ease and
in time for him to take over when Greenspan's term expires at the end
of January.
* Monetary policy, writ large, likely largely unaffected:
We expect that Dr. Bernanke will follow closely in the footsteps of
Greenspan on most policy matters. One key issue where Bernanke and
Greenspan diverge is inflation targeting. Our forecast for the Fed
funds target rate is unchanged following the nomination.
* New chairman raises financial market uncertainty:
Financial markets may become increasingly jittery during the
transition to a new Fed chairman, primarily because any new
information will now have to be filtered through a different lens.
Although financial market performance is largely driven by fundamental
factors, it is our view that the installation of a new Fed chairman
raises the level of uncertainty.
This report has been prepared by UBS Financial Services Inc.
UBS does and seeks to do business with companies covered in its research
reports. As a result, investors should be aware that the firm may have a
conflict of interest that could affect the objectivity of this report.
Investors should consider this report as only a single factor in making
their investment decision.
Bernanke Nominated As Next Fed Chairman
The most important issue is not that Dr. Bernanke will be sitting in
the chair next year, but rather the fact that it will be someone other
than Greenspan
President Bush nominated Dr. Ben Bernanke to succeed Alan Greenspan as
chairman of the Federal Reserve System. In Bernanke, the President has
chosen someone well known in policy, academic and financial market
circles. Dr. Bernanke's qualifications are very strong, and, in our
view, he will likely be confirmed by the Senate with relative ease and
in time to take over for Greenspan when his term expires at the end of
January. If confirmed, Bernanke will become the 14th Fed chairman and
follows in the footsteps of one of the most popular and powerful Fed
chairmen in the institution's history. Progress made over
the past two and a half decades toward a more professional and
independent central bank suggests that the Fed is larger than any one
person-even someone as skilled and respected as Greenspan. However, the
transition to a new Chairmanship still poses challenges for financial
markets given the steady ratcheting down of credit and inflation risk
premiums over the past several years. In our view, the most important
issue is not that Dr. Bernanke will be sitting in the chair next year,
but rather the fact that it will be someone other than Greenspan.
Greenspan's Tenure
Over Greenspan's tenure the unemployment rate and core inflation have
come down on average.
When Chairman Greenspan's term draws to a close at the end of January,
he will depart as the second longest-serving Chairman in the history of
the Fed. (See Table 1.) To put Alan Greenspan's tenure in perspective,
consider that when he joined the Fed as chairman in 1987, the S&P 500
was roughly one-quarter of its current value, the world wide web was
little more than a hobby horse for academicians, Ronald Reagan was still
the President, and bond yields were roughly double their current level.
(See Chart 1 and Chart 2.) While Greenspan has been widely credited with
steering monetary policy with a steady hand, however, his reign has not
been without event. In addition to two relatively minor recessions,
Greenspan has had to maneuver monetary policy in response to the 1987
stock market crash, the savings and loan bailout, the 1997-98 Asian
currency crisis & Russian loan default, the 2000-02 equity bear market,
and the 2001 terrorist attacks.
Measured by the Fed's double mandate of "full employment" and "price
stability," Greenspan's stewardship in the post-war era is rivaled only
by legendary Fed boss William McChesney Martin, Jr. This is not to say
of course, that all the credit for good economic performance can be
attributed to Greenspan alone. However, it remains a fact that during
his tenure as chairman, the unemployment rate and core inflation have
trended lower, on average.
The Evolution of Central Banking
During Greenspan's tenure, monetary policy has become more dependent on
widely accepted principles, such as greater independence and
transparency
Not withstanding Greenspan's larger-than-life status as a master policy
tactician, the conduct of monetary policy has become increasingly
"institutionalized" over the past two decades. Fundamental tenets of
central banking such as independence, transparency and consistency, have
become deeply embedded within the culture of the Fed during Greenspan's
tenure. Rather than simply rely upon the skills of any one person as
some perceive, Fed policy is instead increasingly driven by more formal
procedures that are developed and implemented through a rigorous vetting
process. So while two decades ago monetary policy might have been
likened to driving a vintage Volkswagen "Beetle" where the skill of the
driver was all that mattered, nowadays it is more akin to driving a
sleek new BMW with electronic driving stabilizers, ABS, airbags, and a
navigation system. Although the driver is still ultimately in control of
driving the car, he no longer needs to rely exclusively upon his own
talents to navigate difficult terrain and keep on a steady course.
Greater independence. The transformation of the modern Fed may well have
started with the naming of Paul Volker as Fed Chairman under President
Jimmy Carter. However, it was really not until the early nineties that
central banks gained greater independence from government interference.
Prior to this, both Congress and the White House would typically
pressure senior Fed officials to steer policy in a manner which
maximized the near-term political benefits. More often than not, this
would include cutting interest rates to promote a growth
agenda-regardless of whether or not this was the appropriate course of
action. But as the Fed increasingly exerted its independence, central
bankers became less prone to cave in to political pressure.
Increased transparency. Along with greater independence came greater
transparency. In the aftermath of the high inflation era of the 70s and
80s, academic studies revealed that market expectations were vital for
sound economic performance. Specifically, inflation expectations held by
the public were found to be a primary determinant of inflation itself.
That is, public behavior in response to perceived changes in price
pressures typically helped to drive directional changes in inflation.
The expectations-augmented Phillips curve put forward by Milton Friedman
opened policymakers' eyes to the fact that it was therefore possible to
achieve both lower unemployment and lower inflation if policymaking
institutions-primarily the central bank-could manage to keep inflation
expectations low. In the theoretical framework of the older version of
the Phillips curve such an outcome was not possible. Lower unemployment
could only be achieved by accepting higher inflation and vice versa.
This intellectual breakthrough led Fed Chairman Paul Volcker to
drastically increase interest rates in order to bring down inflation, no
longer fearing a barrage of unemployed as long as inflation expectations
were pushed down accordingly.
Greenspan was successful in institutionalizing greater transparency to
hold down long-term inflation expectations.
So where Volcker was successful, though unpopular, in raising interest
rates to combat the runaway inflation of the 1970s, Greenspan was
successful in institutionalizing greater transparency to hold down
long-term inflation expectations. The best way to manage inflation
expectations was seen to be through more transparent monetary policy
communication and action. Central bankers became more open about
communicating their goals, intentions and views to the public in order
to be transparent and thus achieve credibility in their commitment to
reach the goal of price stability. Only that way could the public's
inflation expectations remain well contained.
Nowadays there is a plethora of academic studies that discuss the
positive effects that central bank independence and transparency have
upon inflation expectations. The main message is that the more
pronounced the former, the lower the latter. With independence and
transparency very well accepted as guiding principles among academics
and policymakers, any future Fed chairman will very likely abide by
these principles, giving him somewhat less discretion over policy
actions and greater chances for long-term success.
A Closer Look at Bernanke
Dr. Bernanke will enter his chairmanship with outstanding credentials.
He graduated from Harvard University in 1975 and earned his Ph.D. at the
Massachusetts Institute of Technology in 1979. Teaching at Stanford
University from 1979-1985, he has been a professor at Princeton
University since then. He has given several important lectures at the
London School of Economics on monetary theory and monetary policy and
written three textbooks on macroeconomics. He is currently Chairman of
the President's Council of Economic Advisers (CEA). Perhaps most
importantly, he was previously a member of the Board of Governors of the
Federal Reserve, serving from August 2002 until just prior to his
swearing-in as CEA chairman in June 2005.
Dr. Bernanke has already proven on many occasions that he can
communicate effectively with the public with regard to public policy
issues.
Strong credentials. While his academic credentials leave no room for
doubt about his suitability for the position, his relatively short
tenure within DC policy circles is still likely to raise some eyebrows.
As we have already noted, while Dr. Bernanke has served as both Governor
of the Federal Reserve Board and Chairman of the Council of Economic
Advisors for President Bush, his job tenure outside of academia has been
limited. What's more, he has never worked for any lengthy period within
the private sector. Unlike Chairman Greenspan who had been a partner in
a well regarded economic consulting firm (Townsend & Greenspan), Dr.
Bernanke has never run a business whose fortunes were left to the whims
of the free market. Still, it is our view that his impressive academic
credentials compensate for his limited policy and private sector
experience. Dr. Bernanke has already proven on many occasions that he
can communicate very effectively with the public with regard to public
policy issues, and we expect that he will continue to do so with even
greater credibility in his new capacity as Fed Chairman.
Politically pliable. As far as political affiliation, it is difficult to
pigeon-hole Dr. Bernanke as either a liberal or conservative. Given the
brevity of his time in public service, he has not left all that much of
a paper trail. However, his appointment as top economist of the White
House and selection as President Bush's candidate to follow Chairman
Greenspan suggest that he tends to lean right. Still, we doubt that his
affiliation will cloud his judgment when making future monetary policy
decisions or giving economic advice to Congress. Mark L. Gertler, a
professor of economics at New York University who has written more than
a dozen papers with Dr. Bernanke said, "He's not ideological. I could
imagine Ben working with economists in the Clinton administration."
Policy continuity. We expect that Dr. Bernanke will follow closely in
the footsteps of Greenspan on most policy matters. One key issue where
Dr. Bernanke and Greenspan diverge is inflation targeting. In Bernanke's
view inflation targeting would increase the transparency of the Fed.
Inflation targeting would entail voicing a value for the so-called
optimal long-run inflation rate (OLIR). This would signal to the public
the level of inflation the Fed is trying to achieve in the long run.
Opponents of a formal inflation target, such as Greenspan, fear an
unnecessary loss of flexibility of the Fed without much of an
incremental transparency benefit. Others fear, that this implicates
Bernanke as a dove on inflation-especially as he advocated such a policy
option directly in response to deflationary concerns. Ultimately,
although Dr. Bernanke's academic work has discussed the benefits of an
explicit inflation target, it is unclear whether he will advance it as a
policy tool as chairman.
Smooth Transition?
Although it is possible that the transition to a new Fed chairman will
proceed without incident, recent history would suggest otherwise.
Although it is possible that the transition to a new Fed chairman will
proceed without incident, history would suggest otherwise. Each of the
past two changeovers has been met with major financial market events in
the first few months on the job. Bond yields rose 200 basis points
during the first three months of Volcker's chairmanship, and the S&P 500
fell 31% from peak to trough during the second month of Greenspan's
tenure, including a 20% decline on October 19, 1987-Black Monday.
In the case of Volcker, the increase in bond
yields was an understandable reaction to his stated policy of bringing
inflation under control through increases in short-term interest rates.
In Greenspan's case, the sell-off in equities was likely a reaction to
tough rhetoric from the Treasury Department on exchange rate policy and
followed a sharp increase in the market PE. Moreover, Greenspan's
nomination was rushed through following Volcker's unexpected
resignation.
By way of contrast, there is unlikely to be a major shift in policy with
the nomination of Dr. Bernanke, but rather a continuation of most policy
objectives advanced by Greenspan. Moreover, the timing of the transition
has been well choreographed, as has the nomination itself. But while
there is little change to policy, and Bernanke was the clear
front-runner heading into the nomination, the very presence of untested
individuals in key positions of power may precipitate more volatile
market behavior. To gauge Dr. Bernanke's potential for success at taking
over the reins at the Fed, we summarized several factors that we think
will be important elements during the transition phase.
The cyclical outlook likely complicates the transition, with inflation
heading higher, economic growth & profits slowing, and twin deficits
expanding.
Financial Markets. The current cyclical outlook will likely complicate
the upcoming transition phase, with inflation heading higher, economic
growth and profits slowing, and the twin deficits expanding. Even beyond
the financial and economic sphere, the combination of heightened
geopolitical concerns, the wars in Iraq and Afghanistan, fears of an
imminent terrorist attack or an avian flu pandemic raise the overall
level of uncertainty and anxiety. In our view, bonds do not fully
reflect this higher level of risk. Bond yields are still below our own
fair value forecast, credit spreads are tight despite an expected
increase in default rates, and breakeven inflation spreads are below our
own estimates for inflation. On the equity side, valuations are closer
to fair value and better reflect an expected slowdown in profit growth.
External power shift. The Fed is now looked upon to set policy in a much
more holistic manner than was the case before Greenspan. Today, the Fed
is pressured in policy circles to take a more activist stance on
monitoring asset prices, reforming government-sponsored enterprises, and
managing exchange rates, to name a few. Some would argue that Greenspan
extended the chairman's reach by testifying to Congress on a litany of
economic and financial matters wholly outside of the Fed's domain.
Others would point out that it reflects the increasing
interconnectedness of many different policy spheres. In other words, to
remain silent on such matters would run the risk that policies made
within these areas might someday influence the future course of monetary
policy and impair the Fed's goal of full employment. Whatever the case
may be, Greenspan delicately usurped authority from other prominent
beltway institutions.
That financial markets and policy makers rely on the Fed as "scholar of
last resort", the greater the risks of disruption during leadership
changes.
The more that financial markets and policy makers rely on the Fed as
"scholar of last resort", the greater the risks of disruption during
changes in leadership. Therefore, we would expect the transition to a
new Fed chairman to be associated with a challenge from other
institutions (Treasury, OMB, Commerce Department) to restore the balance
of power. During this transition period, market participants will face
more uncertainty when trying to understand and analyze new information
in the context of this new power grid. How well Dr. Bernanke establishes
himself as an authority in key policy areas-especially those issues that
are outside the Fed's direct sphere of influence-will go a long way
towards determining his success in the chairman's role.
Internal power shift. Members of the FOMC rarely disagreed with
Greenspan when it came to the official vote totals. (See Table 2.)
However, perceptions that the FOMC has acted as a rubberstamp of
Chairman Greenspan's views may be overstated. A recent paper published
by the Federal Reserve Bank of St. Louis (see The FOMC: Preferences,
Voting, and Consensus, Ellen E. Meade, March/April 2005, pp. 93-101),
surveyed the 1989-1997 FOMC meeting minutes to gauge the level of
disagreement and debate. The paper concluded that FOMC members dissented
during the official vote roughly 7.5% of the time. However, during
meeting deliberations, FOMC voting members would voice their
disagreement with the proposed rate decision roughly 30% of the time and
disagreed with the rate bias about 50% of the time.
That Dr. Bernanke will influence who is selected to fill two vacant
seats on the Fed's Board of Governors will raise his chance of success
over the long-term.
In terms of understanding the power of a Fed chairman and his ability to
forge a consensus, financial market participants look at the number of
dissenting votes rather than the amount of internal debate that occurs
before a vote is held. Were the number of dissenting votes to increase,
financial market participants could question Dr. Bernanke's leadership
ability and political calculus. Bernanke's ability to build a consensus
may prove difficult in the early stages of his chairmanship, given the
complicated cyclical outlook and the potential for a shift in power away
from the chairman and toward the committee. That Dr. Bernanke will now
influence who is selected to fill two vacant seats on the Fed's Board of
Governors may raise his chances of success over the long term, however.
Risk dispersion. The increased information flow made possible by the
Internet and the expanded use of derivatives to disperse risk may have
made the Fed chairman's job easier. As Greenspan intimated in a recent
speech, "increasingly complex financial instruments have contributed to
the development of a far more flexible, efficient, and hence resilient
financial system than the one that existed just a quarter-century ago."
But while the widespread use of certain financial instruments may have
mitigated certain risks, other developments may have produced a
concentration of risk or raised the level of systemic risk, such as the
proliferation of hedge funds and the growth in the mortgage GSEs'
portfolio of retained mortgages. Although it is impossible to know what
risks will ultimately turn into financial market events, some risks may
be consciously ignored or tolerated under the leadership of a trusted
and highly respected Fed chairman but will receive more attention when
that person steps aside.
Inflation credentials. In an era of low and stable inflation, being
"tough on inflation" is no longer a choice-it's a prerequisite. Although
Dr. Bernanke's academic work has discussed the benefits of an explicit
inflation target, it is unclear whether he will advance it as a policy
tool as chairman. There are factions within the Fed that remain opposed
to establishing predefined monetary policy rules, preferring the
advantages of flexibility over rigidity. While Bernanke will likely
advance policies to establish his inflation fighting credentials, his
agenda could be challenged if members of the FOMC advance a
comparatively dovish stance. Whereas Greenspan was eventually able to
build a consensus within the FOMC, a new and untested chairman may find
it difficult at first to steer the FOMC toward his agenda.
Conclusion
Financial markets may become increasingly jittery primarily because any
new information will now have to be filtered through a different lens
By choosing Dr. Bernanke, President Bush nominated a candidate with
strong academic and policy credentials who is well known within the
financial community and who has the capacity to achieve success over the
long term. Nevertheless, financial markets may become increasingly
jittery during the transition to a new Fed chairman, primarily because
any new information will now have to be filtered through a different
lens. Although financial market performance is largely driven by
fundamental factors, it is our view that the installation of a new Fed
chairman raises the level of uncertainty. In particular, it is our view
that the transition to a new Fed chairman may have the following
implications for financial markets:
Our forecast for the Fed funds target rate is unchanged following the
nomination. We continue to expect further Fed tightening over the course
of the next several months.
Bond yields may trend higher across the curve to reflect higher
inflation risk premiums. Dr. Bernanke may prove to be as strong an
inflation fighter as Greenspan over the long term, but his credibility
as an effective inflation fighter and his ability to build consensus
both within the FOMC and within policy circles is untested.
Corporate bonds and other risk assets are trading at historical tight
levels, suggesting that any increase in risk premiums could be reflected
in wider spreads.
Equity markets appear better positioned for increased uncertainty;
valuations are reasonable following steady PE contraction over the past
year. Stocks certainly are not as expensive as they were in 1987 when
Greenspan took office, which followed a period of rapid PE expansion.
Therefore, the risk of a sharp sell-off in equities this time around
appears lower.
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