The local market hit new five year highs yesterday and the Aussie dollar scampered back over the 93 USc level and almost reached 94c after senior US economist and policymaker Larry Summers ruled himself out of the race to replace Ben Bernnake as head of the US Federal Reserve from early 2014.
Mr Summers had been considered a favourite for the job and was being pushed by President Obama, but a growing group of Democrats and private economists had been opposed to his possible nomination because they considered him too close to some of the reforms in the 1990s that are blamed for the GFC.
His withdrawal leaves the Fed’s current vice chairman Janet Yellen the front runner for the biggest job in global finance.
Ms Yellen is considered to be a ‘moderate‘ or ‘dive‘ on the question of the Fed’s current round of stimulatory spending and drives much of the work on this current round, especially the linking of the reduction in the $85 billion a month pace of spending to improvements in the US labor market.
Because she is seen as a moderate, markets reckon there’s a chance the Fed won’t ease, or if it does, will ease more slowly than Mr Summers would have been willing to allow. In other words, investors reckons the ‘risk on‘, sugar hit approach that the Fed’s current easing seems to support, will continue for longer.
So up went markets in Asia, gold, silver and down went the US dollar, and up went the Aussie, jumping more by around a cent at one stage to end at 93.35c from the close at the weekend of 92.45 USc. It hit a high in the morning of 93.98.
In fact major global market indices reached new five year highs as well. And the S&P 500 is closing on its all time high reached in August of 1,707 points.
Emerging markets, which have been hit hard by the withdrawal of investment money ahead of the Fed’ decision this week, saw markets up by 1% to almost 3% overnight.
This line of thinking will only be tested by Thursday morning’s announcement from the Fed and the comments from Mr Bernanke at a media conference. It could be that markets have been too optimistic and if so, a sharp pullback in the Aussie dollar, gold and the local market wouldn’t be a big shock.
The local market rose half a per cent yesterday (adding to last week’s 1.5% gain). The ASX200 was up 28.4 points to 5248. The All Ords gained 27 points, or 0.5%, to 5241.7.
The strong reaction by markets here and offshore to the news of Mr Summers’ withdrawal should be a warning to investors of how febrile sentiment is.
US analysts say there was, in reality, little difference between Mr Summers and Ms Yellen and his withdrawal was put down to political problems in the US Senate.
For that reason, investors should be very wary about reading too much into the gains yesterday and overnight – the real test for market sentiment will happen Thursday morning, our time.
US markets will have a short while to react, but the big test will start in Australia and then in the rest of Asia.
