S&P futures soar 17 points (1%) on Summers dropping out
For weeks I’ve been saying that fear of Summers has been hurting the stock market. Commenters keep responding with a Justin Wolfers analysis that found markets didn’t care about Fed decision:
President Barack Obama recently said that choosing the next chairman of the Federal Reserve is “definitely one of the most important economic decisions that I’ll make in the remainder of my presidency.” The financial media appear to agree, devoting hundreds of column inches to speculation. Senators, overseas pundits and even Bette Midler have chimed in.
But there’s one group that considers the decision largely inconsequential: investors in financial markets. At least, that’s my initial reading of a revealing natural experiment.
I can’t imagine why they’d accept the views of a famous Ivy League professor over my opinion, but they did.
In any case, Steve just left this message in the comment section:
S&P 500 futures gap up 17 points…
And Reuters confirms the story:
SYDNEY (Reuters) – The U.S. dollar slid while bonds and shares rallied in Asia on Monday after Lawrence Summers dropped from the race to be head of the U.S. Federal Reserve.
Investors wagered that Fed policy would stay easier for longer under the other main candidate, Janet Yellen.
. . .
“This move would be consistent with the market re-pricing to reflect a strong probability that Janet Yellen becomes the next Federal Reserve chair.”
The reaction was immediate with the euro jumping over half a U.S. cent to $1.3367 in early trade, its highest in almost three weeks. The dollar likewise slid half a yen to 98.85 and dropped on sterling and the Swiss franc.
Liquidity was somewhat lacking with Japanese markets closed for a holiday on Monday.
Stock futures for the S&P50 mini index climbed 1 percent to 1,705.25, likely setting up a firm start for Asian bourses as well.
In debt markets, futures for the U.S. Treasury 10-year note leaped over a full point, a sizable move for Asian hours, as investors took yields lower.
The more distant Eurodollar contracts rallied sharply as the market pared back expectations for how quickly the Fed might finally start to tighten, as opposed to just tapering its stimulus. Contracts from late 2014 out to 2016 all enjoyed double-digit gains.
Keep in mind that after Senator Tester became the fourth Dem on the Senate Banking Committee to oppose Summers the writing was on the wall. That means the 1% jump in stock prices is a gross underestimate of the damage Summers would have done as Fed chair. Much of this was already priced in.
I feel like we dodged a bullet.
God I love seeing financial markets respond to monetary policy news. Now let’s see the Fed do something exciting on Wednesday. And for God’s sake, let’s get an NGDP futures market up and running.
Update: Taking into account the fact that there was already some expectation Summers would drop out, I’d guess his decision created upwards of a trillion dollars in new global stock market wealth. Not bad!
Monetary policy is really, really important.
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15. September 2013 at 16:39
Gross: Summers’s exit makes Monday a huge day for curve/risk on trades. Treasury 5/30 curve may steepen by 10. Stocks should do very well.
https://twitter.com/PIMCO/statuses/379354656595783681
15. September 2013 at 16:42
Would the Republicans be stupid enough to filibuster Yellen? I wouldn’t put it past them.
15. September 2013 at 16:44
Hard to find anyone (other than WH insiders) unhappy about this. The most common reaction is celebration, including the financial markets.
15. September 2013 at 16:44
Foosion, Yes, that’s plausible.
Tom. If they do then during the filibuster the acting chair of the Fed will be the current vice chair.
And that happens to be . . . Janet Yellen!
15. September 2013 at 16:54
Scott, excellent point that I didn’t think of. Sure hope the President doesn’t screw this up.
15. September 2013 at 16:59
Dr. Sumner you’re being misled by reasoning from a price change.
If the stock market soars due to Fed announcements, it’s purely a nominal anticipation. A higher stock market index doesn’t mean the economy is healthier, or that standards of living are going to rise.
All it means is that investors expect a greater likelihood of a declined purchasing power of the dollar. More dollars means the same stocks trade for more dollars, ceteris paribus.
It does not “hurt” stock market investors to earn a lower nominal return but with a higher purchasing power of the dollars they earn. Similarly, it does not “benefit” stock market investors to earn a higher nominal return but with a lower purchasing power of the dollars they earn.
Never reason from a price change.
15. September 2013 at 17:00
Not sure time to break out champagne…Yellen has authored papers rhapsodizing about 1 percent inflation…Krugman is right, next Fed chair should do something big…is Yellen that type?
Summers, oddly enough, might have tried to make his mark with an aggressive pro-growth stance…Yellen—more of the same, no? Slow asphyxiation. ..
15. September 2013 at 17:06
If Mr. Inflation McInflationary Mugabe Inflationstein was expected to take the role of Fec chair, and the stock market soared 50% overnight on the news, then that wouldn’t mean investors think the economy is any healthier in real terms.
Why would this news about Summers dropping out be any different?
15. September 2013 at 17:06
@ Benjamin
I think you might have a point, but I think the evidence cuts the other way.
Summers has consistently taken the position that further monetary easing creates no marginal benefit.
Yellen has consistently taken the position that the Fed should do more.
I would put my money on Yellen.
So too does the market.
15. September 2013 at 17:11
@ Geoff
So you believe that the economy is currently operating at maximum output? You believe that unemployment will persist at around 7.5% now? If inflation trends down for the next year or so, will you revise your position?
Or do you believe that in a depressed economy that monetary expansion will create ONLY inflation and no additional real output? If so, can you provide the evidence on which you base that belief?
15. September 2013 at 17:12
Oops, I meant to say “If *unemployment* trends down now for the next year or so, will you revise your position?”
15. September 2013 at 17:17
“So you believe that the economy is currently operating at maximum output?”
Inflation does not make the economy run at any greater sustainnable output.
“You believe that unemployment will persist at around 7.5% now?”
Inflation does not reduce unemployment.
“If inflation trends down for the next year or so, will you revise your position?”
What position? To never reason from a price change? To not conflate a rising nominal stock market index with increased standards of living? I don’t think that will ever change.
“Or do you believe that in a depressed economy that monetary expansion will create ONLY inflation and no additional real output?”
How can printing more green pieces of paper make us wealthier?
“If so, can you provide the evidence on which you base that belief?”
It’s the lack of any reason to believe what you believe.
15. September 2013 at 17:17
“Oops, I meant to say “If *unemployment* trends down now for the next year or so, will you revise your position?””
I don’t mistake correlation for causation either.
15. September 2013 at 17:21
S&P 500
1706.50 +18.00
http://www.cmegroup.com/trading/equity-index/us-index/e-mini-sandp500.html
P.S.
I appreciate that you credit me, even when I disagree on other issues.
15. September 2013 at 17:27
Benjamin Cole,
The markets, SG, and I, all disagree with you.
15. September 2013 at 18:12
Well, I’ve never been impressed with Wolfers anyways. I can’t comment on his academic work, however his articles & twitter comments are among the most biased and short-sided of any professional economist in the public eye. His twitter updates on labor market news are great however…..
15. September 2013 at 18:15
I wish I could be a little more confident that Yellen will get the job.
15. September 2013 at 18:17
Scott, et the Bloomberg app on your IPad and watch the futures market across the board. Treasury yields down, gold up, ag down, global equity up, but Japan isn’t buying.
15. September 2013 at 18:33
Imagine two candidates that are substantively identical. At the same time, Candidate B is a controversial lightning rod whose nomination would have led to protracted congressional wranglings, and possibly failed. Candidate B drops out–expected stock market reaction to avoiding such a fiasco? In other words, maybe it’s the much maligned uncertainty fairy, rather than the merits, that is explaining some of the market reaction.
15. September 2013 at 19:20
Great news, Scott but lets not kid ourselves Obama is really in charge of the nominal economy . We might’ve avoided another meltdown, but well likely get more of the same with yellen. I used to get so angry at Bernanke, until I remembered that Paul volcker didn’t move until Reagan supported him, and haruhito Kuroda would not have moved without Shinzo Abe.
Obamas in charge of MP, and that’s a sobering thought
15. September 2013 at 19:51
I’m wondering if the “soaring” futures market is merely due to reduced uncertainty, rather than some implicit applause for Summers withdrawal.
15. September 2013 at 20:50
https://twitter.com/DLin71/status/379358579884838912
15. September 2013 at 21:08
I guess Summers’ lease had all too short a date.
15. September 2013 at 23:07
Isn’t this exactly the sort of bubble-type behaviour that Summers would eradicate?
(tongue-in-cheek).
15. September 2013 at 23:11
Eliezer Yudkowsky comments: https://www.facebook.com/yudkowsky/posts/10151876234884228
(anyone who isn’t following him on facebook or elsewhere is just dumb.)
16. September 2013 at 02:59
The very scary thing is that, if not for Congress, Obama would nominate either Summers or (perhaps his real first choice) Geithner.
One can easily blame Obama for not understanding the role of monetary policy, and one should blame him for not being inquisitive enough to figure it out. But most responsibility lies on the Summers camp (including Geithner, Krugman and, yes, Bernanke). They are more correct than the crazed Austrians or RBC theorists, but by both having the academic credentials and the wrong views, they may have wrought far more harm. They are the ones who should see evidence, such as continued NGDP growth in the midst of austerity, and see the power of expectations and monetary policy. But they’ve set their stake too deeply in the ground of fiscal stimulus and have a reluctance to listen to evidence which boggles my mind.
16. September 2013 at 03:23
Also, the rise in global equities further confirms (if any further confirmation was necessary) the non-zero-sum nature of monetary easing when there is slack in the economy.
16. September 2013 at 03:25
http://www.ft.com/intl/cms/s/0/a78aea30-1e6e-11e3-85e0-00144feab7de.html?siteedition=intl#axzz2f3NJn3HQ
16. September 2013 at 03:33
Meh, not that it will make a difference…
“Inflation does not make the economy run at any greater sustainnable output.
Inflation does not reduce unemployment.”
Those are nice assertions and I’m happy you believe them, but do you have any empirical evidence? Ultimately, empirical evidence and not axiomatic assertions are needed to win arguments.
Inflation does not just magically happen as the Fed prints more money. More money can ONLY lead to inflation through more demand.
To put how demand would decrease unemployment in context, let’s say the minimum wage increases by 5%. Unemployment goes up, correct? But demand for, say, fast food also increases by 5%. Would unemployment still go up in the fast food sector?
Sticky wages are the exact same market distortion, and increase in demand will mean pure inflation in some sectors (such as commodities) without sticky wages while a mix of inflation and employment growth in most sectors (housing, manufacturing, etc.)
Your definition of “sustainable” might mean 30+ years, but I’ll be near retirement in 30+ years. Any realistic analysis of data shows that sticky wages last for at least 10 years. And in those 10+ years, real productivity is improved because of increased demand. Furthermore, the experience that’s would otherwise be wasted in unemployment does increase long-term productivity. So it helps even in the very long run.
“What position? To never reason from a price change? To not conflate a rising nominal stock market index with increased standards of living? I don’t think that will ever change.”
Odds go from the Bears winning at 55% to the Bears winning like 65%. Is it safe to “reason from a price change” and say the Bears are more likely to win? For example, maybe the other team had their RB tear his ACL in practice. Whatever the reason, when real people have real money on the line and they change their opinion, it tends to mean something.
To be fair, the stock market could have gone up just due to interest rates going down. Stock markets can only move if the PV of future cash flows has changed. So if interest rates go down, the PV goes up even without the actual future cash flows changing.
But the analysis I’ve seen at least on movements before has shown that interest rates cannot explain stock market movements in reaction to monetary news. In some cases, interest rates AND stocks have gone up. In which case, interest rates actually acted against the stocks moving upward.
Therefore, the cash flows must also go up. Is the increase in cash flows a pure product of inflation? Well, one can look at a market in inflation specifically, TIPS spreads to see that, and it’s not. Real cash flows are going up, which likely means higher utilization of capital.
“How can printing more green pieces of paper make us wealthier?”
See above. Are you really this dense? Maybe so.
“It’s the lack of any reason to believe what you believe.”
There’s hardly any intuitive reason to believe an electron is in two places at one, or time goes slower (or is it faster) at high speeds, but they’re both experimentally confirmed. How does what you believe explain evidence? For example, how does your view that inflation can’t reduce unemployment explain how countries’ timelines for recovery in the Great Depression match when they left the gold standard? Or the Great Depression in the first place? Lost Decade in Japan? How Iceland has recovered but not Ireland?
16. September 2013 at 04:24
Lots of good comments, I mostly agree. Any information on how TIPS spreads responded to the news?
16. September 2013 at 04:45
Mark Sadowski–
I hope I am wrong and Yellen announces the Fed will taper up until robust growth targets are hit and the Fed is wiping out IOER.
But…I wouldn’t hold my breath…
16. September 2013 at 04:52
To play devil’s advocate, the Irish betting sites had the probability of Summers getting the position at over 80%, yet again illustrating that markets are not always correct a posteriori. Although this is certainly not dispositive as to EMH, it is an interesting anecdote. At least you could have hedged your Treasury position with a bet for or against Summers.
But seriously, I think the mechanics of an NGDP market that directly feeds Fed actions needs to consider the fact that banks will find ways to trade derivative positions that are highly correlated with the NGDP market, but that would not trigger Fed actions. Especially if regulatory requirements on positions in the actual NGDP market are disadvantaged relative to synthetic positions that accomplish the same thing for the bank but not for the monetary supply. What would keep the cash/synthetic basis small and stable?
16. September 2013 at 06:41
Nick, I’m afraid those sites seem to lag what’s going on. I noticed that when it took them a while to figure out that Summers was the frontrunner.
Maybe I should bet more, I won bets on the past two presidential elections.
I don’t quite follow your last paragraph, what is it exactly that you are afraid of? Are you worried that monetary policy might be distorted?
16. September 2013 at 07:30
From the article:
In debt markets, futures for the U.S. Treasury 10-year note leaped over a full point, a sizable move for Asian hours, as investors took yields lower.
Does that matter, Scott?
16. September 2013 at 07:48
[…] Another surprise monetary policy announcement, another example of easier money leading to lower interest rates. […]
16. September 2013 at 07:50
In your paper (as I understand it), the Fed would have a fairly mechanistic rule to perform open market operations in response to trades in the NDGP market. But there are plenty of markets with huge derivative exposure, such that a good way to get exposure to that market is to enter into the derivative contract versus actually interacting in the market. For example, S&P futures versus actually investing in the stock market, or credit default swaps versus buying cash bonds. The choice to pick a cash position versus a synthetic position is based not on the primary effects of the position (both generally go up together and generally go down together), but rather on second order effects such as liquidity, reserve requirements, etc. However, because of the second order effects, the two markets can go in different directions.
In the example of an NGDP market that causes the Fed to buy or sell securities, if there were to develop a large market of NGDP derivatives that did not trade with the Fed, then the Fed’s NGDP futures market and the derived NGDP market could go in different directions. So if the “shadow” derivatives market implies that money is too tight, but the Fed’s own NGDP market implies that money is too loose, then the Fed would tighten despite the “market” saying that it shouldn’t (and vice versa).
This is solved by ensuring that features of the Fed’s NGDP market make it the “best” place for these trades to occur, after accounting for secondary effects such as the ability to obtain leverage, regulatory capital requirements, etc. But those things should be integral to the design, or else the market of “side bets” will carry all of the information that should be in the Fed’s market.
16. September 2013 at 10:31
Bob, Yes, it matters to the tune of 10 basis points.
Nick, I’ve proposed that the Fed do trades with zero transactions costs, and even subsidies if necessary to assure adequate volume. It would be an infinitely liquid market while being targeted, but not thereafter.
16. September 2013 at 10:41
[…] Larry Summers was pulling his name out of the running for Fed chief, Scott wrote a post titled, “S&P futures soar 17 points (1%) on Summers dropping out.” Here are some excerpts from that […]
16. September 2013 at 17:26
“God I love seeing financial markets respond to monetary policy news.”
All socialists love seeing the economy “respond” to central planning.
It piques and satisfies the socialist urge to control the economy.