Lawrence H. Summers, ex-Director of the White House's National Economic Council, gives a speech during a business forum "The United States, China, and Taiwan: Roles and Responsibility in a Global Economy" in Taipei on May 30, 2012.
The big story in markets this past week was not on the equity side of things but in the interest rate realm.
The yield on 30-year and 10-year US Treasuries hit new multi-year highs, continuing this year's theme of higher rates.
Here, via Bloomberg, is a one-week look at the yield on the US 10-year bond.
What's interesting is that the yield didn't seem to rise for all of the usual reasons (i.e. strong economic data leading to talk of "tapering" Fed asset purchases).
Nomura's George Goncalves says the bond weakness has to do with angst surrounding the next Fed chair, and the possibility that Larry Summers will be appointed, and take the Fed in a more hawkish direction, meaning fewer asset purchases, and a faster move away from zero interest rates.
Thin summer volumes, bull trap head-fake and slightly better data exposed UST market weakness; it's no longer just fear of tapering but also uncertainty regarding the next Fed Chair
This past week the US rates market displayed unusual behavior as it didn't require much in order for bonds to get crushed. We wait anxiously for the FOMC minutes and other key Fed events ahead to gauge what lies ahead for USTs. The biggest risk to the bond market and our tactical bullish trades in our model portfolio is the combination of tapering fears and the election of a more hawkish Chairperson. In such a scenario we wouldn't be surprised that investors just sit on the sidelines and see how high rates can go if a hawkish Fed nominee is announced, with an overshoot meaningfully above 3% possible. At such extreme levels, we believe that stocks would be under even more pressure as bonds become competitive again and asset allocation adjustments eventually reverse the flows back into bonds.
While our survey and many economists’ and market participants’ predications are that Yellen is still the favorite, there is real possibility about Summers as a real possibility. The risk is that the people who are calling for Yellen could be wishful thinking as market participants may be addicted to the easy money policies of the Fed. These market participants may not view Yellen as the non-disruptive change agent but instead as dove that is similar to (or in some ways even more dovish than) Bernanke. Some media outlets (most noticeably CNN) and online probability trading sites are predicting that Summers gets the nomination. In our survey, our hedge fund accounts are also expecting Larry to get the nod.
The idea that Summers is "hawkish" compared to Yellen is probably an oversimplification of the differences between them, but that is the blunt way the two are perceived. And we can corroborate that there was tons of Summers talk this week, especially on Friday after reporter John Harwood said on Twitter that a good source of his placed the odds of Summers getting the nomination at 2/3. At least in the short term, it seems like this debate will be part of the interest rate equation.
More From Business Insider