Market volatilities may increase after Yellen’s departure this week, sell USD/JPY?
Departing Fed Chair Janet Yellen is leaving US monetary policy in pretty good shape, and her colleague also successor, Jerome Powell’s job won’t be easy. This is especially so as he is going to find that attaining consensus among the Ph.D. economists is never easy. Any policy uncertainties may increase the demand on safe-haven assets such as gold or yen.
Yellen’s legacy is strong
It is almost certain that Janet Yellen is going to end up with a pretty strong legacy. With growth picking up, unemployment at its lowest and inflation posing no threat, the task of withdrawing the exceptional monetary stimulus that followed after the crash of 2008 seems to be proceeding well. With 5 rate hikes and balance sheet unwinding, things could have gone very wrong. However, the volatilities still remain in historical low range. US and global growth, stock markets and other economic indicators are chugging along with no signs of recession in the foreseeable future.
Powell’s challenge will be on how to manage the upcoming crisis if there is any
The Fed led the way for other central banks with its rapid and aggressive response to the financial crisis, including programs that led to significant changes in its balance sheet. Although the Fed also has a head start on policy normalisation, it has far less room to fight the next downturn. That could be the biggest challenge Fed’s chair Powell faces next.
To combat the consequent downturns, Fed cut rates by 5.5% and 5.25% in the past two easing cycles. With the current pace of removing policy accommodation slowing, the Fed has raised rates 5 times since December 2015. This will cause policy makers to have less ammunition when the next crisis hits. It seems likely that interest-rate policy will reach the zero lower bound again in the future, given an historically thin rate buffer, which leaves little room to ease the policy stance through changes in overnight rates. This will then require the use of unconventional policies. However, Powell seems to favour conventional policy according to his past speeches, especially the one in 2012 when he openly criticised the side-effect of QE.
There’s a lot of uncertainty surrounding the composition of the Board of Governors as there will be four open seats on the seven-member Board when Janet Yellen leaves at the beginning of February, including the Vice Chair position. Many of those names floated to fill those posts have criticised the use of QE in the past. A new leadership creates an additional layer of uncertainty as to how the Fed will be able to address the next downturn.
Furthermore, explaining such a shift would be a test for the new Fed chair. Where Powell stands (as chairman rather than as Yellen's loyal deputy), the need to get in front of any rise in inflation and what his new colleagues make of that vital question will give investors plenty to worry about.
Yellen’s departure on uncertainties
Yellen has been clear about her expectations for the policy direction thanks to the “data dependant” and “forward guidance” which is by telling the market participants what her next move would most likely be. This openness started with her predecessor Ben Bernanke but Yellen took it to a higher level of clearness. This is a key reason behind the low stock market volatility. Although it is not the only reason, she did remove one very big potential surprise. If investors are not able to get what they got from Yellen, stocks, bond and FX investors are about to lose a major underpinning for the record-low volatility.
Moreover, Fed New York President William Dudley is stepping down from his post in mid-2018, several months before his term expires in January 2019. The New York Fed presidency will be key, as this person also oversees implementation of the decisions in money markets. This role is especially important as the Fed begins unwinding its $4.5 trillion balance sheet.
Our Picks
EUR/USD – Slightly bearish.
Some technical retracement could happen after strong rally in this pair in past a few weeks. Price may drop towards 1.2290 this week.
USD/JPY – Slightly bearish.
Uncertainties after Fed’s Yellen’s departure could drive this pair lower towards 108 this week.
XAU/USD (Gold) – Slightly bullish.
We expect price to rise towards 1357 this week.
Fullerton Markets Research Team
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