During recent weeks, gyrations in the Treasury market have become increasingly driven by gyrations in the presidential election polls. Investors generally believe a victory by former Massachusetts governor Mitt Romney is Treasury bond bearish and will lead to higher Treasury yields than would prevail if President Barack Obama wins a second term. This is partly driven by perceptions of how the two candidates’ respective policies may impact growth, taxation and fiscal deficits. However, the linkage between the election outcome and expected Treasury yields is bound most tightly by their potentially divergent approaches to the Federal Reserve.

Regardless of the election outcome, the president will most likely need to nominate a new Fed chairman when Ben Bernanke’s term expires in January 2014. While Bernanke has not made public his intentions, it is widely believed that he is not interested in serving a third term even if given the opportunity. The Fed nomination could very well be the most important one the next president makes due to the controversial nature of current Fed policy and the extraordinary influence it is having on financial markets. Under normal circumstances, the Federal Reserve acts like a pit crew — incrementally adjusting the federal funds rate higher or lower to provide more or less speed to the race car that is the U.S. economy, ensuring that it neither stalls nor overheats. In the current environment, though, the Federal Reserve is more like a tow truck, with the economy tethered to its back, trying to haul the race car across the finish line. The Fed has expanded its balance sheet by $2 trillion since the onset of the financial crisis, engaged in “QE Continuous” whereby that balance sheet will continue expanding for an indefinite period of time, indicated that rates will likely be near zero until at least mid-2015, and in its most recent statement pledged to continue to provide support for “a considerable time after the economic recovery strengthens.” The Fed’s actions have been extraordinary, and its influence on markets unprecedented, making the choice of the next Fed chairman extremely consequential.

If President Obama is elected to a second term, the most likely candidate to replace Bernanke is Janet Yellen, current Vice Chair of the Federal Reserve. From a monetary policy standpoint and a financial markets standpoint, a Yellen-led Fed presages more of the same. Yellen has supported recent Fed decisions and has seemed to take more of a leadership role in recent months. In her June 2012 speech, which introduced the concept of an “optimal control model,” Yellen suggested the appropriate path of monetary policy was perhaps to continue to provide accommodation even as the economy recovers and inflation ticks higher. This approach is strikingly consistent with the recent Fed language committing to remain accommodative long after the economy expands. Yellen is a driving force behind the Fed’s move towards more of a rules-based policy approach, and as chair she would likely continue Bernanke’s work and perhaps even express more of an inclination to expand on innovative Fed programs. Markets should expect continued low interest rates under an Obama second term.