Summers rules himself out, Fed set to Taper and BoE minutes – Big Week Ahead

<p>It’s a big week ahead for the markets. Not only have we seen the hot favourite to be the next Fed Chairman, Larry Summers, remove […]</p>

It’s a big week ahead for the markets. Not only have we seen the hot favourite to be the next Fed Chairman, Larry Summers, remove himself from contention, we also have the most important FOMC decision for months as well as the publishing of the BoE minutes.

The Fed is set to taper
Since early summer, the market has been gearing itself up for the Federal Reserve to start tapering QE. Ben Bernanke, the Fed Chairman, has been communicating to the markets that this is likely to happen before the end of the year. The market has settled on this week’s FOMC decision as the key date.

So what are we expecting?

The market consensus is for the Fed to taper monthly asset purchases to $75bn from $85bn. There are 2 key reasons for this:

1. Payroll misses are not a big enough issue
A $10bn taper would be a fairly modest reduction given debate that has ensued around the timing of tapering after two monthly misses on US payrolls. However, the fact that the 4-week moving average US jobless claims (a better gauge of weekly jobless claims) has fallen progressively to its lowest levels since October 2007, offers perhaps a more consistent theme that the US labour market has sufficiently recovered to warrant minor ‘tapering’. (see chart below).

2. Timing
Bernanke has boxed himself into a corner by pro actively stating tapering will happen before the end of the year. This months’ FOMC decision is conveniently timed with a press conference, giving Bernanke the opportunity to explain the Fed’s rationale in detail. Moreover, Bernanke’s term expires at the end of January. The later he leaves tapering, the arrival and policy of his replacement (likely Janet Yellen) becomes even trickier.

The surprise will be if the Fed does not taper. There is an interesting juxtaposition Bernanke finds himself in as they are expected to cut growth targets, again, and this alongside disappointing payroll figures may make the case for tapering slightly weaker. At the same time, US treasury yields continue to trace higher – 10-year yields were close to touching 3% last week.

So the stakes are high. The market is expecting tapering. What we are likely to see is modest tapering followed by Bernanke talking down expectations of rate hikes and US economic prospects, lowering the expectation level to convince that tapering is just a first step, not aggressive and not fiscal tightening. It’s all in the delivery.

US unemployment rate (red) vs 4-weekly average jobless claims (white).

Larry Summers rules himself out of the race for Fed Chairman

The favourite to replace Ben Bernanke ruled himself out of the race to become the next Chairman of the Federal Reserve last night, sending a shock to the markets.
Summers has been forced into this decision to avoid more political embarrassment for President Obama after Syria. Summers was seen as Obama’s preferred candidate but his ratification by the Senate was seen as progressively tricky over recent weeks as three Democrats signalled their intention to oppose his nomination in the Senate Banking Committee. They did so to force his withdrawal from the process before Obama nominates him and suffers an embarrassing rejection.

So what now? Its between Janet Yellen and Donald Kohn after Timothy Geithner confirmed he still has no intention to take on the job. Yellen becomes the hot favourite and already has seen Democrats ion the Senate announce their preference for her to take over Bernanke. 

The market reaction has been to take on more risk. Yellen is seen as much more dovish than Summers, favouring the QE stance, compared to Summers who was seen as more hawkish and favouring tapering. Stock indices as consequence rallied more than 1% whilst the US Dollar fell 0.4% with the GBP/USD cross rate threatening a break above $1.60 – risk on.

BoE minutes
Last but by no means least, we have the BoE minutes being published on Wednesday, which will provide another interesting insight to whether governor Carney does have the full support of the committee for forward guidance. The minutes may suggest Carney’s honeymoon period is over.

Join our live webinars for the latest analysis and trading ideas. Register now

GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.