The knee-jerk reaction to Summers’ withdrawal boosted asset markets and hit the dollar hard. That is likely to come as little surprise given the market consensus had shifted during the previous two months very much in favour of a Summers’ succession at the Fed.
In that time, two-year US Treasury yields rose sharply and the dollar found support amid increased perceptions that Summers’ instincts were more hawkish than incumbent Fed chairman Ben Bernanke and the other contenders to succeed him at the helm of the US central bank, such as new favourite Janet Yellen.
As Jens Nordvig, head of global currency research at Nomura, puts it, the nomination of Summers as Fed chairman had loomed in the background as a potential Treasury-bearish, dollar-bullish and risk-negative event for two months.
| 'Summers effect' has supported dollar and two-year Treasury yields during past two months |
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Still, some wonder whether the dollar might be better off in the long haul from Summers’ decision.
Steve Barrow, head of currency research at Standard Bank, says while the dollar fell because the market perceived Summers to be more hawkish than Bernanke, there is little evidence for that point of view.
“In fact, many analysts were scrambling around for things Summers has said about monetary policy – and drawing a blank,” he says.
“He did not seem to be a great fan of quantitative easing, but this does not make him a hawk: he might have a preference for other ways to ease monetary conditions.”
Furthermore, the market’s problem with the choice of Summers was probably less to do with whether he was more hawkish or dovish than other contenders and more to do with non-monetary policy issues, such as his closeness to the Obama administration and his reputation as perhaps being less consensual in his management than Bernanke.
“Whether these concerns would have ever been realized is now an unknown,” says Barrow.
“But if these were the important issues, rather than a more hawkish bias, then who is to say that his loss is detrimental to the dollar over the long haul?”
Of course, the flipside to Summers’ withdrawal is the growing assumption that Yellen, the frontrunner according to reports, will secure the nomination as the next Fed chairman.
That has weighed on the dollar as she is perceived to be more dovish in her monetary policy stance and likely to lead to a slower withdrawal of the Fed’s unprecedentedly large liquidity provision.
Indeed, some believe that given her expertise in labour-market conditions, she is unlikely to favour raising interest rates until the unemployment rate falls closer to the non-accelerating inflation rate of unemployment (NAIRU).
NAIRU in the US is perceived to be between 5% and 6% – lower than the Fed’s current commitment to maintain low rates until the unemployment rate reaches 6.5%.
Still, despite that, Yellen’s appointment is not a done deal. Other candidates include ex-Fed member Donald Kohn, who has been mentioned as a potential chairman by US president Barack Obama, and ex-Treasury secretary and ex-Fed member Tim Geithner.
The question for currency investors is whether any candidate will substantially change the Fed’s policy stance and hence alter the consensus for a stronger dollar in the longer term.
Indeed, Nordvig says while Yellen’s appointment could be negative for the dollar given her vocal advocacy for highly accommodative monetary policy, caution is warranted.
“Yellen as chairman would have to represent the consensus of the FOMC to a greater degree than her speeches and statements in recent years,” he warns.
“As such, her public statements as chairman might not appear as dovish as the market currently expects.”
Indeed, whoever is the next Fed chairman, the underlying trend remains one of economic recovery in the US, which will require the normalization of US monetary policy by the central bank.
Lee Hardman, FX strategist at Bank of Tokyo-Mitsubishi UFJ, believes the adjustment higher in US rates and tightening in global financing conditions should continue in the year ahead, even if it might prove more gradual than in recent months.
“In this environment, currencies of countries with elevated current-account deficits are likely to remain fragile while offering support for the US dollar,” he says.
That would not bode well for the sustainability in the sharp relief rallies seen in the likes of the South African rand, Indian rupee and Turkish lira in the aftermath of Summers’ decision.
Beyond the fact it might not have that much of an effect on the eventual normalization of Fed monetary policy, there is another reason why Summers’ withdrawal could benefit the dollar.
That is because seeking his confirmation in the US Senate could have cost Obama valuable political capital. As Geoffrey Yu, strategist at UBS, points out, that could have meant that reaching an agreement on raising the debt ceiling afterwards would have therefore required even greater concessions from Obama and created additional fiscal drag on the US economy.
Overall, it would seem the ripple effects from Summers’ withdrawal from the race to become Fed chairman and the negative impact on the dollar could disappear quickly.