CBA International Economics - 16 September 2013
Yellen now in pole position
- Larry Summers has withdrawn his name from consideration as the next Fed Chair. Janet Yellen is now the front‑runner.
- A Summers nomination would have increased market vol. Summers was perceived to be more hawkish than Yellen.
- Risk assets are likely to be supported early in the week by the Summers announcement. But focus will quickly shift back to the FOMC meeting later in the week.
Summers says no
In a surprising turn of events, early in today’s Asian session Larry Summers withdrew his name from consideration for the role as the next chairman of the US Federal Reserve (Fed). Summers had been viewed as the front runner for the role by market participants and various media outlets.
As we outlined recently, a Summers nomination by President Obama would have likely generated the greatest market reaction. The market moves over recent days, firstly to media reports Summers would be nominated, and then from his withdrawal, illustrates the likely pick up in vol. that could have been generated.
The potentially difficult confirmation process through the US Senate Summers would have endured had he been nominated by Obama was one of the factors behind why we thought market volatility would have increased. A number of Democratic lawmakers had recently publicly expressed their support for current Fed Vice‑Chair Janet Yellen and indicated that they would not vote for Summers. The tricky approval process appears to have been a key reason why Summers’ voluntarily withdrew his candidacy. According to Summers his confirmation could have been “acrimonious and would not serve the interests of the Federal Reserve” or the US’ “ongoing economic recovery”.
Market reaction to continue in the near‑term
The decline in the USD and lift in broader risk assets in today’s Asian trade following Summers’ announcement was largely generated by perceptions Summers was relatively more hawkish than Yellen. The FX market reaction was large in part because the news was released during thin trading and given the closure of Japanese markets.
We expect the positive reaction in global risk assets to continue over the near‑term, as offshore participants, particularly those in the US react to the Summers announcement. Financial assets weighed down by the prospect of tighter US monetary policy such as in select emerging markets, are likely to have the greatest reaction. That being said, we think the Summers‑related moves will peter out quickly as participants re‑focus their attentions on the upcoming FOMC policy meeting (announcement 18 September BST/19 September AEST). We, and the market consensus, expect the Fed to announce a US$10bn tapering of its asset purchases this week. This would reduce the Fed’s asset purchases from US$85bn per month to US$75bn per month (see CBA FX Strategy ‑ FOMC Preview: Tapering and tempering, published 9 September 2013). Even if the Fed tapers its purchases in line with our expectations, we continue to think the Fed will remain cautious and try to
temper any perceptions of a rapid tapering process. Overall, we expect the USD to soften this week.
While our central case is for the Fed to announce a tapering of its asset purchases this week, based on the recent soft patch in the US economic data we do acknowledge there is a risk the Fed delays its announcement to later in the year. Should the Fed not announce a tapering of asset purchases this week, given the level of market expectations we would expect the USD to slump even further.
If not Summers, then who?
Given Summers’ withdrawal, market participants may presume Yellen will now be announced as President Obama’s nominee as the next Fed‑Chair. We agree with this view, and think Yellen would be a strong candidate. In terms of the process, there is no pre‑determined announcement date, but based on the confirmation steps required, an announcement from President Obama is likely over the coming weeks.
As we indicated previously, the nomination of Yellen as the next Fed Chair should have minimal market impact. This is largely because Yellen’s policy views are well known, she is deemed to be consensus orientated with a focus on communication and her appointment would be considered a continuation of the Bernanke era. Yellen was a key figure in the Fed’s policy decision over recent years, and the architect behind its communication policy.
Navigating the Fed’s exit from its current policies poses significant implementation risks, and will be a key task of the next Fed Chair. A relatively seamless transition from a Bernanke‑led Fed to one helmed by Yellen would help quell fears about possible aggressive monetary policy normalisation.
Although Yellen may have moved to the front of the queue in the eyes of market participants, the announcement of another nominee cannot be discounted. Nor can an announcement by current Fed Chair Bernanke that he would like to stay on in the role. Bernanke has not openly discussed his future, but the common view is he will not seek re‑appointment. Bernanke’s future may be a topic of discussion in the Q&A session following this week’s FOMC policy announcement. In the past, Bernanke has declined to be drawn on his future.
In addition to Yellen, the other potential candidate being touted in the media is former Fed Vice‑Chair Donald Kohn. Kohn served as Fed Vice‑Chair during Bernanke’s first term (2006‑2010). Much like Yellen, Kohn is thought to have a cautious approach on monetary policy normalisation. From a policy perspective there appears to be very little between Yellen and Kohn. Former US Treasury Secretary Tim Geithner has also been suggested as a potential nominee, however he continues to stress that he is not interested in the role.