With Election Day just around the corner, the US economy is becoming an increasingly popular theme for politicians. Presidential incumbent Barack Obama seems to be indicating business as usual. But Republican presidential nominee Mitt Romney, who has made the economy the cornerstone of his campaign, has said otherwise: He would make some major changes, starting with who controls US monetary policy.
If Mitt Romney wins office, US Federal Reserve chairman Ben Bernanke is likely out. Romney has said he will ask for Bernanke’s immediate resignation, and if that doesn’t work, he will certainly not reappoint him when the Fed chief’s term expires on Jan. 31, 2014.
Romney hasn’t yet named any potential replacements for Bernanke. But based on his criticism of the nation’s top central banker, it stands to reason that Romney would appoint someone “hawkish,” who aggressively opposes the idea of an activist Fed. This new chairman is likely to: (1) oppose economic-stimulus measures, such as quantitative easing; and (2) oppose the greater regulatory role the Federal Reserve now plays in overseeing our financial system.
So what impact would a Romney-style Fed chairman have on investors and the markets?
End of the bull market in Treasury bonds. Romney’s hypothetical hawkish Chairman would most likely begin by unwinding the Fed’s $2 trillion balance sheet, currently loaded down with bonds purchased to implement the quantitative easing programs. The Fed’s bond purchases have fueled the bull market in Treasury bonds over the past few years, effectively capping Treasury yields and putting a floor under Treasury bond prices. So if the Fed’s bond holdings are sold, yields would begin to rise, and holders of Treasuries would face losses.
Financial equities feeling the pinch. While bankers haven’t been happy about the Fed’s expanded regulatory role, they have been one of the biggest beneficiaries of Bernanke’s easy-money policies. Since the Fed has held interest rates at (or near) zero percent, banks have had an extremely cheap source of funding the past few years. They’ve been lending that money and making other investments at significantly higher rates, ensuring sizable profit margins. Should banks’ funding costs rise, their profit margins would get squeezed, making them less attractive to investors, at least until the pace of lending picks up.
A stronger US dollar. If US interest rates do creep up, the US dollar would probably strengthen against many other global currencies. Oil and other commodity prices, which have an inverse relation to the dollar, would eventually begin to decline, as the initial spike in prices drives down demand. This could dampen the appeal of commodity plays.
A stronger dollar could also negatively impact global exporters, such as Caterpillar (CAT) and General Electric (GE), whose prices would increase in foreign markets. While this effect would be somewhat muted by the global diversification of such companies, it’s still a significant consideration when it comes to analysts’ earnings estimates.
None of this is to say that a hands-off Fed chairman and a strong dollar are necessarily a bad thing. A strong greenback benefits consumers by making imports cheaper and encouraging domestic producers to keep costs down. And a stronger dollar encourages foreign investors to open new plants and operations inside the US, creating more jobs. But it’s important to understand the potential investment impact of a shift in monetary policy, so we can adjust our portfolios accordingly.
Benjamin Shepherd is a recognized exchange traded fund (ETF), mutual fund and stock expert with an extensive background analyzing time-tested funds, their management and value investing strategies which have proven themselves in both bull and bear markets.
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