Macro Wrap – Yellen At Risk of Inheriting a Fed That Has Lost Its Influence Over Markets

by Enis October 9, 2013 7:39 am • Commentary

The overnight price action very much surprised me when I woke up this morning.  If you had asked most traders a couple of months ago how the market would react when Janet Yellen was announced as the new Fed chairman, you’d probably get a lot of “big risk-on day” type of guesses.  Especially if you told them, the SPX index is down 2.5% in the past week, and 4% in the past 3 weeks.

So when I looked at asset price moves this morning, I found it very curious that there was hardly a risk-on tone.  And I’m not just talking about the muzzled reaction in SPX futures.  Perhaps the most bewildering reaction for me was the behavior of EUR/USD.

The Euro has been a bastion of strength in an otherwise choppy market over the last 3 months.  The EUR/USD cross has rallied from below 1.28 to above 1.36 in that period, quite a move for a currency with an implied volatility of only 8.  A good portion of that rally has been caused by the continued dovishness from the Fed.  No taper, no Summers, and now Yellen.  Yellen’s nomination, while expected, is the last piece of the puzzle for QE as far as the eye can see.  But despite that dovish news, the EUR/USD cross reversed overnight, and the Euro is actually lower against the dollar.

Here is the overnight price action, with the green arrow the move right after the announcement, and the red arrow the retracement since then:

EUR/USD intraday, Courtesy of Bloomberg
EUR/USD intraday, Courtesy of Bloomberg

This is one of those moves in financial markets that immediately catches my attention.  When news comes out that should cause an asset price to move one way, but that asset price moves the other way, that’s usually a great indication of the future path of least resistance for that asset.  In other words, if the Yellen announcement can’t even get EUR/USD to go any higher from here, then EUR/USD is likely going lower.

We’ve seen this sort of reaction to recent Fed-related announcements from other asset classes too.  Stocks have sold off ever since their initial rip-roaring rally after the Fed’s no-taper announcement.  Gold and silver have made new lows even as the dovish headlines accumulate.

The news is always less important than the reaction to the news.  As everyone speculates about the widely expected debt ceiling resolution rally, I’m focused on reactions and expectations more than the actual event.  Yellen’s nomination news has been a dud.  That might be an early clue as to the market’s future reaction to any eventual deal in Washington.  Perhaps Chairman Yellen will inherit the worst type of Federal Reserve – one that the market ignores.