With the case for the next Fed chairman having devolved to the most ridiculous of decision trees, such as Nancy Pelosi's "it would be great to have a woman", because apparently gender diversity trumps everything in the eyes of the California democrat, the choice of Bernanke's successor is now more nebulous than ever. It has certainly not been aided by the periodic floating of the Larry Summers trial balloon, especially as originating from the Fed's WSJ mouthpiece who one week presents Summers as the favorite and the next skewers his chances.
However, one person for whom the Summers vote is essentially a done deal with 90% odds, is Scotiabank's Guy Haselmann. Here is his logic.
- Bernanke’s term expires on January 31, 2014. By a large margin, markets expect Yellen to replace him. Conventional wisdom is often wrong. Personally, I place the odds of Larry Summers becoming the next Chairman at 90%. He was a former Treasury Secretary and Obama’s Chief Economic Advisor from 2009-2010. He is close to Obama, who is not afraid to appoint those close to him – even controversial figures – into important positions. Summers probably wants the job and has been lobbying the President for it.
- In last week’s speech by the President he discussed “inequality” and how “it is bad economics”. President Obama said, “when wealth concentrates at the very top, it can inflate unstable bubbles that threaten the economy. When rungs on the ladder of opportunity grow farther and farther apart, it undermines the very essence of American.” When elaborating further, the President used the term “inequality of opportunity”. This is the exact phrase that Summers used in a speech recently. Is it possible that they both believe that QE policy has been more effective at widening the wealth divide than creating middle class jobs?
- There is an interesting article on the website of the Financial Times that may be in tomorrow’s newspaper. It was written by Robin Harding in Washington and entitled, “Summers Dismissed QE Effectiveness”. The article states that Summers said at a conference in April, “QE in my view is less efficacious for the real economy than most people suppose”. If he gets nominated, risk assets should get punished. Bottom line: Buy: vol (puts), swap spreads, CDS, & the dollar. Sell: bonds, equities, and oil.
- If you are Summers and you know you have the nomination locked-up, the most Machiavellian thing you can do is to leak your position ahead of the announcement of your nomination. In other words, it would be wise to steer your direction now and let the market adjust to the new path. Therefore, the press stories about how he questions the efficacy of QE may not be a coincidence.
- Since the process has become more time-consuming in recent years, Obama may wish to announce it ‘early’. Moreover, if the White House expects an adverse market reaction, could an announcement occur during the summer when many are on vacation to weaken the impact?
- The current FOMC would likely know with more certainty than the markets that Yellen is not going to get the nod. Could this affect the votes or timing for tapering? Wouldn’t it be less-bad for markets and the reputation of the Fed if the current FOMC (under Bernanke’s leadership) were to taper and end QE, than it would for Summers to take the helm and end asset purchases?
- There are other changes occurring at the heart of the FOMC. Governors Duke and Raskin have resigned. It is possible others will use Bernanke’s departure as an excuse to also leave. Certainly, it is not a bad time to monetize experience. In addition, two hawks (Fisher and Plosser) become voters in 2014. New individuals could side with the hawks or new (non-Yellen) Chairman who simply may not be fully onboard with the efficacy of QE benefits. There are heightened risks to the unwinding process of the Fed’s experiment when left in the hands of individuals who may not have fully believed in its merits in the first place.
- With QE, ZIRP and promises of ‘doing more’ if necessary, investors have been selling volatility for the past few years as a yield-enhancement strategy. Portfolios felt they no longer needed downside protection in the form of puts, because the Fed has provided the downside-risk insurance for them. Those days are over. Furthermore, investors should now stop interpreting low-volatility levels as a sign of safety - something which is contributing to the already highlevels of investor complacency.
- After hearing the President over the weekend, my conviction remains strong. The President is sharping his rhetoric about “growing income inequality” and how “reversing these trends has to be Washington’s highest priority”. The President is fully aware that Fed’s QE policy exacerbates the wealth divide, because the rise in asset prices that result, benefits the wealthiest Americans.
- Over the weekend the president said, “And when unemployment is still too high, and long-term unemployment is still too high, and there’s still weak demand in a lot of industries, I want a Fed chairman that can step back and look at that objectively and say, let’s make sure that we’re growing the economy, but let’s also keep an eye on inflation. If the markets start frothing up, let’s make sure we’re not creating new bubbles.”
As usual, our personal view is that whoever Goldman greenlights as Bernanke's replacement, is who will be the next Chairman. Oddly enough, the market odds do not even account for the current head of the NY Fed, former Goldmanite, Bill Dudley stepping into Bernanke's shoes.
This may be a very lucrative oversight to anyone who takes the greater than Nassim Taleb 1000/1 odds.