Wall Street grapples with Fed power shift, policy

NEW YORK — Wall Street, which is already grappling with a transition to a less-friendly Federal Reserve, next must navigate a leadership change at the central bank, a power transfer that in the past has caused heightened market volatility.

On Friday, Fed Chairman Ben Bernanke, the architect of the Fed's unprecedented and market-friendly bond-buying program, dubbed quantitative easing, will depart. He will hand over the title of world's most important central banker to current Vice Chair Janet Yellen, a Fed veteran who championed Bernanke's policies and is expected to stick with the Fed's current plan when she takes over.

The power transfer comes at a time when the Fed is in the early stages of unwinding its massive QE stimulus program, and financial markets are in turmoil.

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On Wednesday, the Dow Jones industrial average fell for the sixth time in the past seven sessions, plunging 190 points to 15,739. The Dow is down 5.1% in January, which is when the Fed started dialing back its bond purchases, a policy rolled out in late 2008 to keep borrowing costs low and boost the economy.

The Fed said Wednesday that it would cut back on its monthly purchases of long-term Treasuries and mortgage-backed bonds by an additional $10 billion a month to $65 billion, keeping it on track to wind down its purchases, which peaked at $85 billion in 2013, later this year. The decision to taper further came despite ongoing turbulence in emerging markets, where central bankers in Turkey and South Africa hiked interest rates in an attempt to defend their battered currencies and stave off a crisis.

On her first day as Fed chief on Monday, Yellen will be tested.

History says stocks might face a test as well. The broad U.S. market has fallen 2.5%, on average, and traded higher only 40% of the time in the first three months after a new Fed chair takes over, according to Piper Jaffray data. "The entire ton! e of the Fed will change," says Craig Johnson, a Piper strategist. Stocks were down 4.6% three months after inflation-slayer Paul Volcker took over in August 1979 and fell 26.5% after Alan Greenspan grabbed the reins two months before the 1987 crash.

The current changing of the guard at the Fed could prove tricky once again, says Boris Rjavinski, interest rate strategist at UBS.

"We see higher risks than in previous transitions," he says.

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Potential stumbling blocks in the early days of the Yellen era include:

• A communications gap? While Yellen's views on monetary policy are well known, what's important is how she communicates those views to a market that dissects every syllable for policy clues, warns Rjavinski.

"Greenspan and Bernanke mastered the art of communication, which kind of helped them get the type of market response they wanted," Rjavinski says. "The question is will Yellen be as good a communicator as her predecessors?"

• New voice, new uncertainty? Investors abhor uncertainty, and a new face in such a big, high-profile job equates to an unknown. "When you have a new (Fed chief), you never really know what you get until they sit down in the chair," says Bill Mann, chief investment officer at Motley Fool Funds. The fact Yellen has to unwind a Fed policy that no other central banker has ever faced adds to the uncertainty.

• An inflexible exit plan? Now that Bernanke has tapered twice in succession and in equal $10 billion increments, it could reduce Yellen's flexibility if circumstances change, warns Donald Luskin of Trend Macrolytics.

"Bernanke has handed Yellen a fait accompli, an established policy trend that will be difficult for her to contradict," he told clients.

Not to worry, counters Krishna Memani, chief investment officer at Oppenheimer Funds. "Bernanke-to-Yellen is probably the easiest transition! in the F! ed's history," he says. "They two have worked together for years. The continuity of policy was one of the objectives in picking Yellen."