Less Risk Aversion than in January

February 13, 2014

The Ary twins of January and February are wintry lot, and the season has been dished out in very abundantly in 2014 — so much so that it’s become very hard to interpret U.S. economic data.  Under Janet Yellen, nonetheless, the Federal Reserve isn’t backing away from the measured and predictable scale-back of quantitative easing.  Only an abundance of less distorted evidence of slower growth in U.S. GDP and deterioration of the labor market, sufficiently so as to change the outlook held by monetary officials will change the tapering course, and it will take a number of more months at the least for such a point to be reached. 

Before this month, anticipated Fed tapering and its onset had generated risk aversion that hit equities, bonds and emerging market currencies to differing degrees.  February has been different.  Contrary to some speculation of a more dovish Fed, Janet Yellen has continued the policy begun by Ben Bernanke of phasing out quantitative easing gradually but determinedly and at the same time differentiating that tactic from interest rate policy.  A virtual zero interest rate policy in fact and forward guidance into 2015 if not longer hasn’t flinched in this new chapter of Fed stewardship.  And yet, the first half of February has seen discernibly less risk aversion in financial markets than experienced in January.  The dollar, yen and yuan have fallen against European currencies.  Share prices have trimmed the prior month’s losses.  Moderately higher Treasury yields are being taken in stride.  Gold, oil, and other commodities are up, too.

Several factors could account for the market’s better mood.

A favorable impression of Yellen’s testimony is one.  Grilled by a committee of mostly men, many hostile to Fed policy and the idea of a woman leading the institution, Chairman Yellen demonstrated a strong command of economic conditions and the merits of the Fed’s approach.  She did not seem overwhelmed by the testimony and demonstrated an ability to explain complicated issues succinctly and in a way that most people understood.  She exuded confidence in her role and projected calm to investors wanting to believe that U.S. monetary policy lies in good hands.  One cannot understate the importance of personal leadership in shaping the effectiveness of central bank policy, and first impressions can be really important.  A Fed Chairman with the nickname Maestro is going to get the benefit of the doubt.  In contrast, the first ECB President, the late Wim Duisenberg, had a knack for kicking own goals, and the weakest euro levels were seen on his watch, long before Euroland’s debt crisis. 

The U.S. Congress avoided another eleventh hour game of chicken over raising the debt ceiling.  House Speaker Boehner’s decision to avoid a conflict the Republicans were never going to win has left the Conservative wing of the party crying betrayal, but apolitical world investors applaud his act of courage and understand that the decision is unambiguously the correct one especially in light of the very sharp drop in the Federal deficit.

A third anxiety that was defused came from the German constitutional court.  While ruling OMT illegal under German law, the court said it was not its call to decide the legality of a policy of the European Central Bank, a pan-European institution.  If the European Court takes up the matter, a decision wouldn’t be handed down for at least a year, and the ruling is likely to be different and support the ECB’s action.  It was feared that the formerly troubled economies in the euro area could have been engulfed in new crisis if the German court had declared OMT unconstitutional without the caveat that in fact was attached.

A final factor is the severe U.S. weather.  Financial market trends need continuity.  That’s especially true in the 24-hour market of foreign exchange where the baton circles from Europe to the United States to Asia and back to Europe.  Throw in a holiday, and momentum is often lost.  That is especially true if U.S. leadership is the missing element.  Wild weather affecting millions of Americans have robbed the business day and business week of any sense of rhythm this month.

Whatever the combination of causes, let’s hope the risk-on psychology continues.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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