Continuity is critical

President Biden's public opinion rating has taken a hit recently, but the markets approved of his nomination of Federal Reserve Chair Jerome Powell to a second term. While the decision was a vote of confidence in his ability to navigate monetary policy in uncertain times, it had everything to do with continuity. Other than criticizing lawmakers for dragging their feet on new fiscal stimulus last fall, Powell has worked well with Congress. And despite defending various Fed stances, he has acknowledged worrisome developments such as rising inflation, giving him credibility with investors. Although Lael Brainard certainly is qualified, Powell was the right choice.

The persistence of the pandemic is one reason we need the status quo. The emergence of the omicron variant has highlighted that. But the most pressing motivation for continuity is the tapering of the Fed's monthly asset purchases, which began in mid-November with a reduction of $10 billion of Treasuries and $5 billion of mortgaged-backed securities. It's crucial this succeeds without spooking the markets, and the selection of a new Fed chair might have done that. While policymakers left wiggle room for the path to be altered by implementing only two months of tapering, any deviation will need a delicate touch. Some Fed officials, including Powell yesterday, have suggested picking up the pace if inflation remains high. But if omicron or something else slows the economic recovery, or if inflation retreats, the Fed might have to pause it. That's enough uncertainty.

Viewed in this context, Brainard's nomination for vice chair isn't a consolation prize, but a shrewd move. For one, her reportedly more dovish stance could moderate a hawkish trend. Second, it elevates the issues of reform and regulation demanded by progressives. Lastly, it presents a succession plan, always a good idea when it comes to monetary policy. Of course, politicians are sure to complicate that, whether through infighting or a cross-party struggle.

There's plenty of political theater at present. Congress first must extend federal funding to avoid another government shutdown. More important to the money markets is that lawmakers address the debt ceiling. They punted in October when they approved additional funds many thought would last until early December. Treasury Secretary Janet Yellen recently said mid-December is more likely and has acknowledged the Treasury's own wiggle room. Unfortunately, this takes pressure off Congress to act, but she had to calm investors. While the picture is clouded because of the typical haze of year-end activity, the possibility of a default remains very low. We hope there will be an agreement on a long-term solution rather than another short-term fix, but don't doubt it will be resolved.

The front end of the Treasury yield curve has reflected the debt limit drama, with 1-month bills offering about double the yield of 6-month bills and essentially equal to that of 12-month Treasuries. Expecting the curve to steepen and attractive investment opportunities to arise after the situation is resolved, in the middle of November we lowered the weighted average maturity (WAM) target range of our government money market funds to 30-40 days from 35-45 days. We kept of our prime and municipal funds in target ranges of 40-50 days.