KRUGER INSIGHTS WEDNESDAY, OCTOBER 9, 2013

By: Joel Kruger

YELLEN BUT NOT SCREAMIN – Today will be a real test for markets. Finally some closure on the Fed Chair drama, with the President to officially announce the appointment of Janet Yellen later on (3pm New York). I had warned that any Kohn speculation was misguided, and that Obama was actually hinting at Yellen and not Kohn in his interview with John Harwood. Obama wanted to appease hawks by saying the Fed Chair would be focused on inflation and asset bubble risks just as much as unemployment risks. His intention was to let markets know that they should not assume that Yellen would be as dovish as everyone suspected. Still, there is no denying that Janet Yellen is a major dove, and as correlations stand, this would in theory be a supportive development for risk assets, and the stock market should rally on the news. But should it really? Well, this is why I say today will be a real test for markets.  

IT’S ALL PRICED IN - No matter what, my views are still bearish risk assets over the medium-term. So if the market does in fact rally today because of the Yellen appointment, it really changes nothing. However, if the market is not able to recover on the news, it will send a very serious message to bulls that this could really be it for a while and we have indeed carved out a significant top. I don’t believe the market should rally too much on the Yellen news for two key reasons. 1) As much as there was speculation over who would be the next Fed Chair, it was pretty much a lock that Yellen would end up getting the nod. As such, this news had all but been priced in. 2) Even with a dovish Yellen at the helm, there really isn’t much more that she can do but leave policy as is for a more extended period of time. So in my view, this appointment is actually in some ways a good thing for my bearish risk asset position, as the markets will now price in as much dovishness as they can, leaving the risk for letdown tilted to the hawkish/bearish risk asset side of the equation.

JUST THE FACTS - As I have reminded repeatedly since the stock market broke to fresh record highs earlier in the year, above the previous 2007 peak, monetary policy is the way it is because things are not good and we are living in unusual times. So while this policy does incentivize a counterintuitive flight to risk in troubled times, there is only so far this relationship can extend before it becomes exhausted. If the economy is truly in a state that still requires such extraordinary accommodation, then it stands to reason that a stock market trading just off record highs might be a tad overdone and due for some weakness. So what are the implications for the currency market? Well, I still believe that the US Dollar is the place you want to be. While there are those that would argue that this appointment and all that is going on in the US with the government shutdown and debt ceiling debate, are factors that should weigh on the buck, I still see these developments as risk negative and inspiring a flight to safety reaction into the US Dollar. If I were a foreign investor in US equities and US equities started to fall, I would rather liquidate and leave my money in US Dollars, than liquidate and repatriate into a currency that is likely to suffer at the ends of another global downturn.