Dollar Slides As Summers Is Out - Calling Bernanke?

Includes: UDN, UUP
by: Tim Clayton

The dollar has been undermined sharply by the decision of Summers to withdraw from the Fed Chairman's race with EUR/USD spiking to over 1.3350 in the dead-zone ahead of the retail open and remaining under pressure. The principal casualty of this affair will be President Obama who has endured a disastrous month, first over Syria and now the Fed Chairmanship. There will also be a lack of confidence in the whole Treasury team which looked to engineer a Summers appointment.

From a market perspective, the initial dollar sell-off is likely to be an over-reaction and should be seen as a short-term buying opportunity as Summers would not have been as hawkish as assumed. The affair has, however, damaged the underlying US bullish case as overall confidence in economic policy will be damaged and will not be won back easily. Obama may also have to rethink the entire strategy as he has destroyed the credibility of all the main Fed candidates. Don't be surprised if Bernanke is persuaded to do one more year.

The decision by Larry Summers to withdraw from the race to succeed Bernanke as Fed Chairman has undermined the dollar sharply at the beginning of the Asian session on Sunday evening US time. The dollar had gained support late last week on news reports that Summers was set to be appointed at the end of this week and has weakened sharply on the news with EUR/USD moving above the 1.3350 level and USD/JPY below 99.0.

This leaked Nikkei report on Friday certainly had a big impact in that it hardened the potential opposition to Summers within the Senate. Ever since the suggestion of his nomination was made, there have been important voices of opposition to Summers and it must have become clear over the weekend that Summers would either not be approved or would have such opposition as to have been extremely damaging.

There had been expectations that Summers would look to withdraw quantitative easing more quickly than current Vice-Chairman Yellen and this had been assumed to be positive for the dollar. In the longer-term context, it is doubtful whether this would have been true as Summers would still have pursued an aggressive monetary policy.

The immediate focus now will be on who will be the next Fed Chairman given that it won't be Summers. In theory, Yellen would now be the logical choice, but the situation has been seriously complicated by the botched attempt to get Summers in place. Yellen would now clearly be seen as a second-choice candidate and would run a high risk of being a lame duck from the start which would seriously compromise her authority.

The potential third candidate Kohn will also now come under consideration, although again he will have the same problem and would be seen as a third-choice Chairman. It is, therefore, entirely possible that Obama will have to start the process again. It is also possible that he will have to ask Bernanke a favour and encourage him to extend his tenure, for example, by one year to give some breathing space. Obama will also face a much more difficult task in appointing new Fed Governors over the next few months.

This has been a very poor month for Obama with a huge failure of authority over Syria and now a huge error of judgment and totally botched effort over the Fed Chairmanship. Markets do not react favourably to such evidence of poor leadership.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.