By Luciana Lopez
NEW YORK (Reuters) - Investors took the withdrawal on Sunday of former Treasury Secretary Larry Summers as a candidate to head the U.S. Federal Reserve as a green light for risk, betting the bank's next chief would extend an era of easy money that has flooded global markets with cash.
Markets viewed Summers' move as leaving Fed number two Janet Yellen, a well-known advocate of looser monetary policy to support the U.S. recovery, the favourite to succeed the current chairman, Ben Bernanke.
Still, Yellen's nomination remains uncertain, leaving open the possibility that markets would react differently should one of several other possible nominees be chosen.
U.S. stock index futures and Treasury futures rallied as a result of the news, and investors and analysts said those gains will likely extend further into the Monday session.
"My first thought was that the markets will rally on this," said Scott Frew, managing partner and owner of Rockingham Capital Advisors in Hartford, Connecticut. "There's certainly a perception that Yellen is more dovish than Summers."
The Fed has taken extraordinary steps to try to buoy the world's largest economy both during and after the financial crisis.
Currently the bank is buying $85 billion per month in Treasuries and mortgage-backed securities, its quantitative easing program.
That wave of easy money has helped take U.S. stocks to record highs and yields on U.S. government debt to record lows.
On a total return basis, the S&P 500 stock index (REU:^) is up 20 percent so far this year - its best return since 2009, when stocks began recovering from their swoon during the financial crisis in which they lost more than half their value.
The Fed's efforts to keep interest rates low have sent investors scurrying for yield. High-yield debt - known as junk bonds because of their low ratings - has sold steadily, with the Merrill Lynch US High Yield Master II Index <.MERH0A0> surging about 126 percent from 2009 through 2013.
Globally, investors have borrowed in dollars to invest in higher-yielding markets abroad, the so-called carry trade. MSCI's 45-country world index <.MIWD00000PUS> is up about 12 percent so far this year.
But the view that the Fed could withdraw its stimulus soon has rocked global markets, taking benchmark U.S. Treasuries yields to above 3 percent recently, a more than two-year high - underscoring how the U.S. central bank's every move affects investors big and small all over the world.
A spike in rates is worrisome because U.S. government debt is used as a benchmark around the world for everything from obscure derivatives contracts to mortgage rates.
If, in fact, yields rise too high, some economists fret the U.S. recovery could be derailed. Mortgage applications in the latest week fell, as 30-year mortgage rates matched a year-high of 4.8 percent - well over 100 basis points from earlier in the year.
Yellen has been a forceful advocate of the aggressive steps taken under Bernanke to spur U.S. economic growth, earning her a reputation as a policy "dove" who would tolerate a bit more inflation to drive down unemployment that she deemed too high.
Analysts said a Yellen nomination would boost markets because of that sense of continuing Bernanke's approach.
"I expect not only a rally in stocks but also a decrease in yields, as the Fed remains in the same path Bernanke set" under a Yellen nomination, said Michael Yoshikami, CEO and Founder at Destination Wealth Management in Walnut Creek, California.
Markets had already been leaning back into riskier assets such as stocks on a raft of strong U.S. economic data and eased worries about a military strike on Syria.
Investors in funds based in the United States poured $12.8 billion into stock funds in the latest week, according to data from Thomson Reuters' Lipper service.
But Yellen's nomination - and her perceived dovishness - are hardly guaranteed, with other options such as Donald Kohn, Roger Ferguson or Timothy Geithner - who has said he does not want the job - possibly in the mix.
"The Obama administration has shown little, if any, enthusiasm for Yellen, however, so we're not convinced she will necessarily get the nod," noted Paul Ashworth, chief U.S. economist at Capital Economics in Toronto.
The Federal Open Market Committee meets on September 17 and 18 and will discuss whether to slow the bank's asset purchase program.
(Reporting by Luciana Lopez and Rodrigo Campos; Editing by Jackie Frank)