Tapering, Bernanke and Summers! Oh, my!

September 13, 2013 1:22 PM EDT
Market participants will have a lot to contemplate this weekend. Maybe the most ever. Some people's brains may explode in the process.

What we are talking about is: Fed tapering next week, Ben Bernanke's replacement and how much of this is priced in.

Fed QE Tapering:

The FOMC meeting is scheduled September 17-18. It is widely expected that the Fed will taper its $85 billion monthly bond buying program for the first time since instituting the plan. Many are expecting a 'taper lite' - with the consensus looking for a $10 billion haircut. If taper lite is enacted, all is not lost. The Fed will still be barreling $75 billion of fresh money into the system each month. This is in addition to reinvesting principal payments from its holdings and the rolling over of maturing Treasury securities at auction. Also, the federal funds rate remains at 0 to 1/4 percent until at least unemployment falls below 6 1/2 percent. In essence, the Fed is still juicing the system - just to a slightly lesser extent. That said, the move would signal the first solid step to get the U.S. off life support with a goal of ending bond purchases in mid-2014.

Ben Bernanke Replacement:

Fed Chairman Ben Bernanke's term is set to expire on January 31, 2014 and an announcement is expected shortly on his replacement. The news cannot be understated. Mr. Bernanke has been the architect of the post-credit crisis recovery. He has taken the Fed to places no one knew was possible: lowering the Fed funds rate to near-zero, expanding the Fed's balance sheet to $3.66 trillion, instituting a massive treasury and mortgage bond buying program, to name a few. His replacement will be crucial. Two names have come up as front runners for the spot: Janet Yellen and Larry Summers.

Yellen is considered by some as more dovish than Bernanke. She is seen as a great candidate given her experience at the FOMC since 2004, her call in 2007 that showed she was concerned about frothiness in markets prior to many of her colleagues, and her close work with Mr. Bernanke. Initially Yellen was seen as a front-runner, but recently her star has faded.

While Yellen's star has been fading, Larry Summers' has been rising. Larry Summers is a widely-respected economist. He served as Treasury Secretary from 1999-2001 under Clinton, and was Director of President Obama's National Economic Council from January 2009 to November 2010. He was also President of Harvard University from 2001-2006 and was most recently a professor there. On policy, Summers is seen as middle-of-the road although there are concerns about his seemingly non-flexibility and rigid nature.

What's Priced In?

This, of course, is the toughest question to answer. On tapering, it should be noted that Mr. Bernanke first talked about Fed tapering in mid-June, or three months ago. Interest rates have surged on the realization that the biggest buyer is stepping back. However, what it feels like in the Treasury and MBS markets once they are physically out (or, initially in the market to a lesser extent) could a different story. Consensus is a $10 billion per month tapering next week, but more importantly could be any guidance on a schedule going forward (ie - is the Fed on target for a mid-2014 end or has recent data changed that time table?).

On Bernanke's replacement, Yellen is seen as a better near-term choice for a QE-junkie market, although the market is being conditioned for Larry Summers. There have been no fewer than a dozen reports claiming Summers has the job locked up. Today, for example, the Nikkei reported that the White House would name Summers to the job next week. These reports were later shot down by the White House, although chatter continues. It is unclear if the market really puts much faith in these Summer reports, however. Today, when the Nikkei reported Summers got the job markets reacted negatively. This could suggest the market has not fully priced in Summers.


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Ben S. Bernanke, Federal Open Market Committee, Barack Obama, Larry Summers