Larry Summers’ withdrawal from the race for Fed chair will likely be interpreted by markets as bullish for US interest rate curve trades, duration more generally, and risk assets (including credit and equities). It may also impact the manner in which the outcome of this week’s important Fed policy meeting is interpreted by markets.
With Summers’ exit, Janet Yellen regains her well-earned status of front runner. So, absent new news on other candidates, markets will likely interpret this as significantly increasing the probability of broad policy continuity at the Fed. This would be seen as being particularly supportive for the front end of the Treasury curve. Immediate beneficial effects would also be felt by other segments of fixed income and equities.
In thinking about the market implications of the Summers’ news (and recognising that it is still premature to completely rule out other candidates), we should also remember that the Fed may well be on the verge this week of a taper in its monthly purchases of market securities. Given the still-tepid nature of economic growth and job creation, Fed officials may also look to reduce the possibility of disruptive market reactions by evolving the forward guidance component of their experimental policy stance.
Yellen’s renewed front runner status would be viewed by markets as moderating the expected pace of additional taper, as well as increasing the scope for more aggressive use of forward guidance (the credibility of which would be enhanced, other things being equal, by the higher probability of Yellen’s appointment). This would provide additional support to curve trades and duration more generally.
Bottom line: Expect some pretty significant market moves on Monday.
